Investment and the pandemic

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By MICHAEL ROBERTS*

Capitalist economies will remain depressed and eventually see an increase in inflation, thus forming a new phase in which depression turns into stagflation.

Last week's speech by Federal Reserve Chairman Jay Powell at the Peterson Institute for International Economics, Washington, was truly shocking. Powell told his audience of economists that "the scope and speed of this crisis is unprecedented in modern times." He himself summarized a finding from a special Fed survey of the 'economic well-being' of US households: "Among people who worked in February, nearly 40% of households earning less than $40.000 a year had lost a job in March. Now, he himself classified this discovery as shocking.

Powell warned his high-paying audience sitting at home watching Zoom that “while the economic response has been timely and suitably large, it may not be the final chapter as the path forward is highly uncertain and subject to significant downside risks.” . In fact, downgrades of global growth forecasts are still emerging as the horizon appears uncertain; as a result, the number of bulls predicting a V-shaped recovery is starting to dwindle. In fact, only the rulers and financiers continue to hold this opinion.

Another study projects that US GDP will decline by 22% compared to the pre-COVID-19 period and that 24% of US jobs are likely to be in vulnerable conditions. The adverse effects are further estimated to be strongest for low-wage workers, who can experience job reductions of up to 42%. It is estimated that high-wage workers are likely to experience only a 7% reduction.

Powell is concerned that this collapse could hinder a quick or meaningful recovery, causing permanent damage to the US economy. “The historical record shows that deeper and longer recessions can leave permanent damage to the productive capacity of the economy” – said Powell, echoing the same arguments that were presented here in a post about the economic “scars” of the current crisis.

Powell considered the main difficulty in obtaining a recovery after the end of the pandemic: “a prolonged recession and a weak recovery could also discourage investment and business expansion, further limiting the resurgence of jobs, the growth of the capital stock and the growth of pace of technological evolution. Ultimately, it is quite possible that a prolonged period of low productivity growth and stagnant incomes will come.”

He pointed to a serious risk: the longer the recovery took to happen, the greater the likelihood of bankruptcies and collapse of non-financial companies, as well as banks. As “the recovery may take some time to gain momentum, as time passes, liquidity problems can turn into solvency problems”.

In fact, last week the Federal Reserve released its Half-yearly Financial Stability Report, in which he concluded that “asset prices remain vulnerable to significant price declines; if the pandemic takes an unexpected course, the economic consequences could prove very adverse; tensions in the financial system could re-emerge.” The Fed's report warned lenders that they could face "losses" on loans made to borrowers who will not be able to return to balance after the crisis. “Balance and trade balance tensions due to the economic and financial shocks, which have been building since March, are likely to create weaknesses that will last for some time,” the Fed wrote. “The prospect of losses in financial institutions, which may create pressures in the medium term, seems quite high,” said the central bank's report.

Therefore, the crisis associated with the coronavirus will be deep and long-lasting. Furthermore, it will be followed by a weak recovery that could also cause a financial meltdown. Workers are sure to suffer severely, especially those at the bottom of the steep earnings ladder. Well, that was the message from the head of the most powerful central bank in the world.

However, Jay Powell emphasized to his audience of economic agents that this terrifying slump was not capitalism's fault. Powell went to great lengths to try to show that the cause of the dip was the pandemic and the lockdowns required by it – and not the functioning economy as such. “The current slowdown is unique because it is attributable to the virus and the measures taken to limit its spread through the population. This time” – he said – “there was no problem due to high inflation. There was no credit bubble that carried the risk of a burst; no unsustainable booms have occurred in the recent past. So the virus is the cause – not the usual suspects. And this is something worth bearing in mind when facing questions.”

This statement reminded me of what here (on the blog The next recession) was said in mid-March, at the time the coronavirus was declared a pandemic by the World Health Organization. “I am sure that, when this disaster is over, the dominant economic theory and the capitalist authorities will claim that this crisis originated from an exogenous cause, which has nothing to do with inherent flaws in the capitalist mode of production or in the social structure of society. . The virus was the author. The response to such an argument was then to remind readers that “even before the pandemic, in most large capitalist economies, whether in the so-called developed world or in the 'developing' economies of the 'Global South', economic activity was already slowing down when pandemic started. Some economies, and thus production and investment, were already in the process of contracting”.

Following Powell's comment, it was necessary to revise the real growth rate of global GDP since the end of the Great Recession in 2009. Based on IMF data, one can see that annual growth was on a downward path; in 2019, global growth was the slowest since the Great Recession of 2007-08 (left chart below). And if we compare last year's 2019 real GDP growth rate with the average of 10 years before, all areas of the world showed a significant drop (chart on the right and below).

https://aterraeredonda.com.br/wp-content/uploads/2020/06/eleu01.png

Eurozone growth was 11% below the 10-year average; the G7 and advanced economies underperformed even more; the growth rate of emerging markets was 27% lower; the global growth rate in 2019 was 23% lower than the average since the end of the Great Recession. I added Latin America to show that this region experienced a major decline that extended into 2019.

Therefore, the world capitalist economy was already entering a recession (much behind expectations) before the arrival of the coronavirus pandemic. Why? Well, as Brian Green explained, a credit-fueled bubble over the last six years has allowed the US economy to grow even as profitability has fallen and so has investment in the so-called “real” economy. Thus – says Brian – “the underlying health of the global capitalist economy was poor before the plague, but it was overshadowed by cheap money driving speculative gains that fueled the economy”.

For this discussion, it is useful to look at the trajectory of capital profitability in global terms. Penn World Tables 9.1 provides a new series called the internal rate of return on capital (IRR) for almost every country in the world from 1950 through 2017. The IRR is a reasonable proxy for a Marxist measure of the rate of profit on the stock of capital, though of course not equivalent to it, because it excludes variable capital and stocks of raw materials (working capital) from the denominator. Despite this shortcoming, this measure (IRR) allows considering trends and trajectories of profitability in capitalist economies, as well as comparing them with each other based on a similar basis of evaluation.

If one looks at the IRR of the seven major capitalist economies, i.e., the set of major imperialist countries, called the G7, one discovers that the rate of profit in the major economies peaked at the end of the “neoliberal era”, i.e. in the late 90s. There was a significant decline in profitability after 2005, as well as a decline during the Great Recession. Recovery since the end of the Great Recession has been limited, and profitability has mostly remained low and unexciting.

https://aterraeredonda.com.br/wp-content/uploads/2020/06/eleu01.png

The series of these rates of return only go up to 2017. It would be possible to extend these results to 2019 using the AMECO database, which measures the net return on capital in a similar way to Penn World. It has not yet been possible to make this adjustment correctly, but a direct look suggests that there has been no increase in profitability in the core economies since 2017; it is probably even if there was a slight drop between 2017 and 2019.

Second, it is also possible to evaluate this performance by analyzing the total profit of the companies – and not just the profitability. Brian did this for the US and China as well. I have tried to extend US and Chinese corporate earnings movements to a global measure by weighting corporate earnings (released quarterly) for selected major economies: US, UK, China, Canada, Japan and Germany. These economies make up more than 50% of the world's GDP. What this measure reveals is that global corporate profits ground to a halt before the pandemic hit. Marx's dual law of profit, therefore, was already in operation when the pandemic hit (the "double law" occurs when the rate of profit and the mass of profit fall together).

https://aterraeredonda.com.br/wp-content/uploads/2020/06/eleu01.png

A small profit boom started in early 2016 and reached a peak in mid-2017 to return to zero in 2018 to 2019. This allows us to better think about the causal connection between profits and the performance of capitalist economies. Over the years, this blog has presented theoretical arguments for the validity of the Marxist view that profits drive capitalist investment – ​​not “trust”, not sales, not credit, etc. Furthermore, profits drive investment – ​​not the other way around, as is sometimes thought. It is not just the logic of the theory that supports this view; it is also empirical evidence. There is a plethora of this type of evidence.

But here it is necessary to draw the attention of readers to a recently published article (April 2020) by Alexiou and Trachanas that seeks to predict post-war American recessions based on a statistical technique known as “probit”. These two authors investigated the relationship between American recessions and the profitability of capital using this type of regression analysis. They found that the probability of recessions increases with falling profitability and vice versa. Furthermore, changes in private credit, interest rates and Tobin's Q (stock market values ​​compared to fixed asset values) were not statistically significant, which leads to the conclusion that one cannot strongly associate them with recessions .

Based on this study and other previous ones mentioned in the blog The next recession it is clear that fictitious capital (credit and shares) can keep the capitalist economy afloat for a certain time; however, it will always be the profitability of capital in the productive sector that causes its collapse. In addition, actions such as cutting interest rates to zero or less, injecting credit at astronomical levels (thus increasing speculative investment in financial assets and therefore also increasing the Tobin's Q index), raising fiscal spending, all this will still not allow capitalist economies to recover from the current crisis that has been inflated by the coronavirus pandemic. That is, in other words, recovery will depend on a significant increase in the profitability of productive capital.

If you look at investment rates (measured by total investment to GDP in the economy), you find that over the past ten years, total investment to GDP in major economies has remained weak; indeed, in 2019, total investment (government, housing and business) relative to GDP was even lower than in 2007. In other words, the low real GDP growth rate in the major economies over the last ten years has been accompanied by the total investment decline. And if you remove the government and the housing sector from that amount, you will see that business investment performed even worse.

https://aterraeredonda.com.br/wp-content/uploads/2020/06/eleu01.png

By the way, the argument of Keynesian economists according to which the low economic growth in the last ten years is due to the “secular stagnation” caused by an “excess of savings” does not seem to have been confirmed. The national saving rate in advanced capitalist economies, in 2019, is not higher than in 2007, while the investment rate fell by 7%. There was a shortage of investment, not an excess of savings. This last excess results from low profitability in the main capitalist economies; behold, it forces companies to seek to invest abroad where profitability appears to be greater (the rate of investment in emerging economies increased by 10%).

What really matters to restore economic growth in a capitalist economy is the pace of industrial investment (broadly defined). And that depends on the profitability that this investment can provide. Now, even before the pandemic, industrial or productive investment was falling. See the case of Europe. Even before the pandemic, business investment in peripheral European countries was still around 20% below pre-crisis levels.

Andrew Kenningham, chief economist at Capital economics in Europe, predicted that business investment in the eurozone would fall at an annual rate of 24% in 2020, contributing to an expected GDP contraction of around 12%. In the first quarter, France recorded its largest contraction in gross fixed capital formation of any seen in the past. Spain's contraction was also close to a record, according to preliminary data from its national statistics offices.

In Europe, manufacturers of investment goods – those used as inputs for the production of other goods and services such as machinery, trucks and equipment – ​​have seen a big drop in industrial activity, according to official data. In Germany, production of capital goods fell 17% in March compared with the previous month, more than double the drop in production of consumer goods. France and Spain recorded even greater differences

Low profitability and rising debt are the two walls, ten years after the outbreak of the Long Depression, against which major economies are now banging their heads. In this pandemic time, governments and central banks are doubling down on economic stimulus policies, backed by an approving chorus of Keynesians of various stripes (MMT etc.), in the hope and expectation that this will succeed in reviving capitalist economies after the lockdowns have been relaxed or terminated.

This is unlikely to happen because profitability will remain low and may even decline, while debts will mount, fueled by massive credit expansion. The capitalist economies will remain depressed and, eventually, they will see an increase in inflation, thus forming a new phase in which the depression becomes stagflation. The Keynesian multiplier (government spending) will prove in short supply just as it did in the 1970s. The Marxist multiplier (profitability) will prove a better guide to understanding the nature of the booms and busts of economic activity under capitalism. He will show that capitalist crises cannot disappear as long as the capitalist mode of production is preserved.

*Michael Roberts is an economist. Author, among other books, of The Great Recession: A Marxist View.

Translation: Eleutério Prado

Originally posted on the blog The next recession blog.

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