A remarkable feature of the commentary on today’s economic troubles is that despite constant reference to the Great Depression of the 1930s, as well as to the downturns since the Second World War (particularly the relatively severe recession of 1981), there has been little mention of the fact that business depressions have been a recurrent feature of the capitalist economy. But even the briefest attention to history makes recent events appear considerably less unusual. Major downturns have been identified in every decade from the 1820s forward, increasing steadily in seriousness up to the Big One in 1929. In 1835, for instance, the National Gazette reported on the speculative boom set off in the United States by the expansion in trade made possible by the westward extension of canals and railroads (the value of New York City real estate increased 150 per cent between 1830 and 1837). Speculation
in stocks and real property is more general and extravagant than it has been before . . . in all our principal cities . . . [M]ultitudes are now prominent and desperate dealers in the stock and other speculation markets, of classes and ages, callings and positions in life, that formerly were never seen nor expected, and themselves never thought of acting, in such scenes . . . They chase bubbles not less intently than those who have leisure and money to spare.1
By 1837, bank failures had led to a collapse of domestic and external trade. ‘Business firms failed by the hundreds, and workers were turned away from factory doors. In the West and South thousands of farmers lost their lands. Paper fortunes were wiped out overnight.’2 The post-Civil War growth of American industrial capitalism led to even more serious downturns. In 1893, notably, ‘some 500 banks and 16,000 business firms had been financially ruined’, ushering in a deep depression, with a 25 per cent decline in economic activity and unemployment of 15 to 20 per cent, setting off wide spread social unrest.3
From the early 1800s to the late 1930s, in fact, capitalism experienced depressions during between a third and a half of its history (depending on how they are dated by different authorities).4 Sometimes, as in 1847–51, they gave rise to significant social upheavals; at other times, as in 1857–9, the disruption of life and the suffering they occasioned awoke little political response. Overall, they became deeper and longer over this period. In the decades after the recovery from the Great Depression of 1929–39,5 however, the relative shallowness of economic fluctuations encouraged even those who did research into the economy’s ups and downs to ignore the potential for social disruption demonstrated in earlier recessions. Todd Knoop’s recent textbook on the subject goes so far as to conclude that ‘the study of depressions is a somewhat different topic than the study of business cycles in general’. It is from this perspective that Knoop, in a striking denial of the facts of history, describes the depression of the 1930s as ‘unprecedented’,6 and that so many economists could find the current depression so unexpected and difficult to explain.
This is a reversion to the earliest mode of study of depressions, which saw them as isolated events, each with its own explanation. By the later nineteenth century, however, it was understood that crises were part of a recurrent cycle of events, which has to be understood as such, rather than as a series of unrelated phenomena. In every case the crisis led to a recession, marked by a decline in industrial production, rising unemployment, falling wages (and other prices) and failures of financial institutions, preceded or followed by financial panics and credit crunches; in every case, the downturn was eventually followed by a return to greater levels of production (and employment) than before. Thus the idea of economic crisis evolved into recognition of what in English went under the names of the ‘trade cycle’ or ‘business cycle’, a pattern of events which, given its constant repetition, was clearly endemic to modern society.
The seventeenth and eighteenth centuries had already experienced financial panics in the European cities – London, Paris, Amsterdam – in which the growing importance of money in social life had led to the development of stock markets and other modes of finance. (A notable example was the collapse of the market in tulip bulbs in Amsterdam in 1637, the first recorded bubble.) But something new emerged when an increasingly money-centred economy gave rise to the Industrial Revolution and the establishment of capitalism in wide enough swathes of territory for it to become the dominant social system: crises of the social system as a whole. Before that, of course, social production and consumption were disrupted by a variety of disturbances: war, plague, bad harvests. But the coming of capitalism brought something new: starvation alongside good harvests and mountains of food; idle factories and unemployed workers in peacetime des pite need for the goods they produced. Such breakdowns in the normal process of production, distribution and consumption were now due not to natural or political causes but to specifically economic factors: lack of money to purchase needed goods, profits too low to make production worthwhile.
At first only the most capitalistically developed nations were affected (the 1825 crisis took in only Great Britain and the United States). But over the next hundred years, as capitalism spread across the world and countries were increasingly linked by trade and capital movements, the cycle of crisis, recession, recovery and prosperity took in ever more areas, although not all experienced these phases in the same way, to the same extent or at the same moment. By the end of the nineteenth century, the alternation of prosperity and depression was disturbing enough to demand attention from social analysts, even if there was little room for it in the accepted frameworks of theoretical economics.
In 1860, the French Académie des Sciences Morales et Politiques sponsored a competition to ‘Inquire into the causes, and indicate the effects of commercial crises that took place in Europe and North America during the XIX Century . . . As commercial relations have expanded, the perturbations crises bring with them are also touching more and more regions.’7 The prize was won by Clément Juglar, who demonstrated the regularity of cycles on the basis of extensive statistical research. A physician by profession, Juglar mobilized concepts of normality and systemic disturbance to demonstrate that crises, despite their individual features, followed a recurrent cycle of phases suggesting that ‘crises, like illnesses’, are ‘one of the conditions of existence of societies in which commerce and industry dominate’.8 Seventy years later, despite a voluminous series of articles, pamphlets and books devoted to the topic, the absence of a generally accepted theory led the Assembly of the League of Nations – in view of ‘the persistence with which depressions occur’ and ‘the gravity of their economic and social effects’ – to sponsor a major study of prosperity and depression,9 which came out in the midst of the most serious economic collapse in history.
Because both classical and neoclassical thinking had no theoretical room for systemic breakdowns, it was heterodox thinkers who did the pioneering research into the boom-bust cycle. J.-C.-L. Simonde de Sismondi, the initiator of business-cycle theory, wrote his New Principles of Political Economy (1819) in response to the doubts raised in his mind about the ideas of Adam Smith by ‘the business crisis Europe had experienced in the last few years; the cruel sufferings of the factory workers I witnessed in Italy, Switzerland and France, and which all public accounts showed to be equally severe in England, Germany and Belgium.’10 Sismondi came up with many of the explanations appealed to by other theorists since his time: the unplanned nature of the vast market economy; the fact that consumers’ income is less than the value of goods produced; the related idea that more is invested in production than is justified by the extent of the market; and the unequal distribution of income.
Some of these ideas were also advanced, at around the same time, by Thomas Malthus, unconvinced by Ricardo’s insistence that a general crisis of the economic system (as opposed to temporary disequilibria) is simply impossible. These thoughts – ancestors of many subsequent ‘disproportionality’, ‘under-consumption’ and ‘overproduction’ theories of crisis – draw their plausibility from the fact that in a market economy decisions about where to invest money and about what is produced, and in what quantities, are made prior to finding out what quantities of particular goods are actually wanted by consumers, and at what price. This seems obviously relevant to recurrent fluctuations in economic activity, in which different parts of a complex system adjust to each other over time. Another basic aspect of capitalism – that in order for profit to exist, the total money value of goods produced must be greater than the total money paid out in wages – suggests an inherent imbalance between production and eventual consumption. As both of these are constant features of this society, however, it is hard to see how they can explain the alternation between periods of growth and collapses serious enough, on occasion, to give large numbers of people the idea that the system was actually breaking down.
The most important, and most unorthodox, writer to tackle the question of the business cycle was Karl Marx. The nature and causes of economic crisis, and of the relation of crisis to prosperity, are central themes running through the thousands of pages he devoted to the ‘critique of political economy’ of which he published a single volume in 1867 under the title Capital (materials for the remaining volumes were edited and published by others after his death). Marx argued that capitalism’s basic nature produced a tendency to crisis, which was realized in recurring depressions and would eventually bring the downfall of the system. Marx’s approach differed so fundamentally from the generality of economic theorizing, however, that it proved difficult for others interested in the subject (including most of those who called themselves Marxists) even to understand his ideas, much less find them useful.
The year 1867 saw another attempt at explaining the economic cycle, an article in which English economist John Mills found its cause in the changing emotional states of investors, which swing wildly from optimism to pessimism and back. This idea has had a long life, in many different forms (Juglar, for instance, emphasized the over-optimism of investors in a period of prosperity); its most recent revival, widely hailed as a novel contribution to economic theory, is George Akerlof’s and Robert Schiller’s book Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (2009).11 Other thinkers found the cause of the cycle in the weather, as in William Stanley Jevons’s dogged efforts, starting with a publication in 1875, to prove a correlation between business ups and downs and the sunspot cycle, which he believed influenced agricultural yields and so the general state of the economy.
As these examples suggest, a common theme in business cycle theorizing has been the location of the origin of depressions outside the economic system proper; this approach remains basic to contemporary cycle theory, which seeks origins in ‘exogenous shocks’, and particularly in mistaken government policies. Thus Christina Romer, the first head of President Obama’s Council of Economic Advisors, has written that
there is no reason why cycles have to occur at all. The prevailing view among economists is that there is a level of economic activity, often referred to as full employment [of all inputs to the production process], at which the economy could stay forever . . . If nothing disturbs the economy, the full-employment level of output, which naturally tends to grow as the population increases and new technologies are discovered, can be maintained forever . . . Business cycles do occur, however, because disturbances . . . push the economy above or below full employment.
By ‘disturbances’ she means such phenomena as substantial rises or falls in government spending and waves of optimism or pessimism among consumers or firms.12
In an earlier day, however, Gottfried von Haberler had concluded from his 1937 survey of business-cycle theories and history for the League of Nations that crises ‘cannot be accounted for by such “external” causes as bad harvests due to weather conditions, general strikes, lock-outs, earthquakes, the sudden obstruction of international trade channels and the like’. Finding this ‘mysterious’ – because of a presumed ‘inherent tendency of the economic system towards equilibrium’ that he, like Professor Romer, accepted as a feature of capitalism – Haberler defined depressions as ‘those prolonged and conspicuous falls in the volume of production, real income and employment which can only be explained by the operation of factors originating within the economic system itself, and in the first instance by an insufficiency of monetary demand and the absence of a sufficient margin between price and cost’.13 These two factors are obviously related, as a restricted market puts downward pressure on prices and so limits the price for which goods, whose costs were determined at an earlier moment, can be sold.
In the efforts made by researchers to follow Juglar’s example by studying quantities of statistical materials, the theoretical biases of the German Historical School and the Institutionalism of Thorstein Veblen and his followers in the United States played an important role: both emphasized social-historical facts as a basis for understanding the economy, in contrast to the high level of mathematicized abstraction favoured by the neoclassical mainstream. While important work was done by socially critical thinkers like the Russian Michael von Tugan-Baranowski,14 the most significant and long-term research project was that initiated by an American student of Veblen’s, Wesley C. Mitchell, at first independently, and then under the aegis of the National Bureau of Economic Research, founded in 1920. This empirical work produced genuine advances in the understanding of business ups and downs.
It became clear, for one thing, that the idea of a business cycle is a theoretical construction unifying a complex set of processes. Mitchell began the volume in which he presented the results of a statistical investigation into the cycle by observing that ‘we have no statistical evidence of business cycles as whole. What the data show us are the fluctuations of particular processes . . .’. Thus the cycles ‘turned out to be complexes, made up of divergent fluctuations in many processes’.15 To say that ‘the business cycle’ is ‘a synthetic product of the imagination’,16 however, is to accord it the same status as all scientific constructs. It is not to deny that it names something real, only to say that this reality, statistical in nature, is a matter of the interrelations between a large number of processes that produce the alternation of prosperity and depression experienced in the form of such phenomena as business slowdowns, unemployment and financial crises at some times, and as investment booms, increased trade, increased employment and financial opportunity at others.
It was the large number of factors constituting business cycles that led to the competing explanations of the phenomenon, each taking one factor as primary. One of Mitchell’s great contributions was his emphasis on the fact that what links these processes together is the practice that gives the modern social production system a unified history: the buying and selling of goods for money. Businesses buy goods from other businesses and labour from workers, who buy goods from businesses; these exchanges take the form of flows of money between businesses, individuals and banks or other financial institutions. Crises involve breakdowns in these flows, as bills can’t be paid and investments, wage-payments and purchases are cut; the return of prosperity involves an expanded flow of money through the economy as new investments are made and workers are rehired. This is why, Mitchell observed, it ‘is not until the uses of money have reached an advanced stage in a country that its economic vicissitudes take on the character of business cycles’.17
What makes money so central to modern society is that most goods and services are produced by businesses, and businesses are primarily engaged in the effort to make money. That is what business is about: using money to make money. The name for the money made by business is ‘profit’, the difference (in Mitchell’s definition of a commonplace concept) ‘between the prices which an enterprise pays for all the things it must buy, and the prices which the enterprise receives for all the things it sells’. Since a business enterprise must regularly turn a profit to continue to prosper, ‘the making of profits is of necessity the controlling aim of business management’, and decisions about where to invest and so what to produce are regulated by the quest for profit. Thus, as Mitchell put it: ‘In business the useful goods produced by an enterprise are not the ends of endeavor, but the means toward earning profits.’18 A company that does not turn a profit will soon go out of business; goods that cannot be sold at a profit will not be produced. Hence, most generally, ‘Economic activity in a money-making world . . . depends upon the factors which affect present or prospective profits.’19
Investment decisions are not just a matter of the expectations stressed by economic theory, but equally of the actual ability to invest, since the money available for investment is either drawn from existing profits or borrowed against future profits, which must then come into existence if loans are to be repaid and the process is to continue. At some times businesses do better across the economy as a whole, earning more profit, on average, than at other times. When average profits are high society enjoys prosperity, but declining profits can lead to depression. All of this seems so obvious that what is surprising is the inability of most economists to grasp the mechanics of the process. With the advantage of a concentration on empirical studies of business conditions, together with his basic understanding of capitalism as a system centred on the production of money profits, Mitchell was led by his researches to the same conclusion as Haberler, that depressions are due to ‘the absence of a sufficient margin between price and cost’, that is, to insufficient profitability, while the opposite condition produces prosperity.
The absence of discussion of profitability as determining the state of the economy is as striking a feature of current economic writing, outside of a handful of left-wing outsiders, as the refusal to recognize the earlier history of depressions. This is probably due to the central place of the concept of ‘national income’ in macroeconomic theorizing (theorizing about the economy as a whole). The concept of ‘growth’, for instance, so central to contemporary economic discourse, is conventionally variously defined in terms of ‘national income’, defined as the market value of all goods and services produced in a country in a given year (GDP), as the total income earned by the sale of those goods and services or as the total amount spent on purchasing these goods and services (these three money totals are assumed to be equivalent).20 In this total the profits of businesses enter as one sort of price or income alongside others, and thus only as a constituent of, rather than the chief determinant of, the overall state of the economy. In a society whose system of production and consumption is dominated by business, itself dominated by the need to earn a profit, growth – expansion of the system – is, as we have seen, a function of profitability. The national-income point of view, however, focuses on the overall change in income (or product value) produced by changes in profit ability, so that consumer spending and investment in means of production seem to be independent contributors to economic growth.
In this, contemporary theorizing follows the founding example of Keynes himself. This is not surprising, as Keynes was the modern re-inventor of what is now called macroeconomics,21 and the modern system of income accounts was devised to aid in Keynes-inspired policy-making. Since he was, after all, theorizing about capitalism, Keynes began The General Theory with a discussion of profit, also denoted ‘entrepreneur’s income’, understood as what a businessman ‘endeavours to maximize when he is deciding what amount of employment to offer’. But Keynes put theoretical stress on what he called ‘the total income resulting from the employment given by the entrepreneur’, consisting of profit plus factor cost (i.e. the prices of means of production and labour).22 This was in order to move, a page or so later, to his central interest, the relation of the level of investment, and so of employment, to consumption and savings as fractions of the ‘aggregate real income’ of ‘the community’ as a whole.23
In this way, as Philip Mirowski points out, ‘the national-income concept was effectively severed from capital, permitting the rate of increase of income to be analytically divorced from the rate of profit on capital’24 (the latter – in Keynes’s terminology, the ‘marginal efficiency of capital’ – now figures as one of the determinants of investment and so of national income). This is because Keynes, although he did not accept the neoclassical economists’ doctrine that economic crisis was impossible, shared with them the basic idea that the economy is essentially a vast mechanism for allocating resources to satisfy consumption needs. On this assumption, the market’s allocation of part of society’s product to entrepreneurs as profit is just a way to get them to invest, in the interests of society as a whole. If the level of profit ability is insufficient, Keynes reasoned, increasing employment and consumption by other means, specifically by government deficit spending, will lead to prosperity and continued growth.
Interestingly, as Mirowski has also noted, Keynes’s use of the national income concept seems to have been indebted to W. C. Mitchell’s work at the NBER, whose first research report was a statistical estimate of this quantity for the US. And in fact already in his 1927 study of business cycles, Mitchell moved from an emphasis on profitability as the key to cyclical phenomena, through the description of profits as ‘the most variable type of income’, to the complex flow of money payments throughout the economy as a whole, which makes profits ‘subject to perturbations from a multitude of unpredictable causes’.25 Although he emphasized profits as the factor dominating capitalist dynamics, Mitchell had no theoretical explanation for the vagaries of profitability. Thus he was finally left with no more to say than that ‘defects in the system of guiding economic activity [by market-price relations] and the bewildering complexity of the task itself allow the processes of economic life to fall into those recurrent disorders which constitute crises and depressions.’26
An apparent counter-example to the neglect of profit ability in contemporary business-cycle theorizing can be found in the views of the post-Keynesian economist Hyman P. Minsky, who argued like Mitchell that the ‘validation of business debt’, which makes possible continued financing and so ongoing economic activity, ‘requires that prices and outputs be such that almost all firms earn large enough surpluses over labor and material costs’ – profits, in other words – ‘either to fulfill the gross payments required by debt or to induce refinancing’. Profits, in turn, are in his view determined by the scale of investment, which sets the demand for output and so makes possible (the realization of this possibility is simply assumed, without explanation) the appearance of a surplus above costs. And for Minsky, as for Keynes, investment is determined by ‘the subjective nature of expectations about the future course of investment, as well as the subjective determination by bankers and their business clients of the appropriate liability structure for the financing of positions in different types of capital assets’.27 Thus the rate of profit, a determinant of investors’ expectations, is itself explained as a product of the expectation-driven behaviour of entrepreneurs and bankers.
Recent research into the American economy has confirmed Mitchell’s common-sense focus on profits as central to the explanation of business fluctuations. As one important survey of American statistical material, carried out by economists whom no one could accuse of political radicalism, concluded, ‘The effects of profit . . . dominate investment movements.’28 And since investment determines the amount of money available to hire workers (and so for workers to spend on consumer goods) and to buy raw materials and plant and equipment, the growth or decline in investment affects the growth or decline of the economy as a whole. This explains why, as a recent study noted, profits stagnated or even began to decline several quarters before each of the three recessions, starting respectively in 1990, 2001 and 2007. Profit data going back to the last decades of the nineteenth century, when they were first collected, shows that something similar occurred in each of the recessions that the US economy has gone through since that time.29
Hence we are left with these basic questions: why do profits fall in the course of business expansions, and rise in the course of depressions? If profit is the difference between costs and sale prices, both measured in money, what determines the size of this difference? Since changes in the production and consumption of goods and services seem to be determined by relations between the money prices of these goods and services, what regulates these relations? These questions lead to the fundamental question: what is money, anyway, in a modern economy, such that business success or failure is determined by monetary gain or loss? These are questions that even a historically oriented economist like Mitchell did not think to ask, because he took for granted the existence of money as a means for coordinating social production and distribution activities. Asking them, for an inhabitant of capitalist society, would be like an ancient Egyptian asking why Osiris was in control of the Nile’s ebb and flow and so of the rise and fall of agricultural output. Answering them requires sufficient intellectual distance from the conventions of our own society to step outside of everyday economic thinking and the theoretical elaborations of it formulated by economists, to consider money (and so profit) as historically peculiar social institutions, with particular consequences for the way we live.