Stagnating economy, thriving finance

by Costas Lapavitsas

21 April 2014

Are mature economies in long-term stagnation? In the four years since the great crisis of 2007-9, the USA has grown at an annual rate of 2.2%, Germany 2%, Japan 1.6% and the UK 1%. Considering that the GDP of these countries shrunk by a total of 4-6% during the crisis, they have just about made up this lost ground - and the UK has not even achieved that. Meanwhile, the prospects for growth in 2014 and beyond look far from brigh.

Some well-known economists have begun to sound very worried. Larry Summers, for instance, has claimed that long-term stagnation is the ‘new normal’. The reason is that the interest rates required for sustained, privately-led growth would actually be negative. Since nominal rates cannot fall below zero, mature economies can break out of stagnation only if they have a financial bubble. This is a bit like taking amphetamines: there is a heavy price to pay when the bubble bursts. Paul Krugman has essentially concurred, describing the current state of affairs as a ‘liquidity trap’. For both economists, the answer is decisive expansion of public spending.

There is little doubt that weak economic performance in 2010-13 is the result of the policies implemented to confront the crisis. States aimed to support the financial system, while passing the costs onto society at large. Thus, central banks supplied large amounts of money and drove interest rates practically to zero, while governments guaranteed the solvency of financial institutions. Bank profitability was quickly restored and the financial system was able to start a new bubble, this time in the stock market. In sharp contrast, real wages were kept stagnant, or falling, and public expenditure was restricted. Quite naturally, working people reduced their consumption and began to pay back the gigantic debts accumulated during 2001-7. In all, government policy has prevented a repetition of the Great Depression of the 1930s, but demand and growth have been very weak, despite the gradual emergence of a new bubble.

The real issue, however, is whether mature economies are in long-term stagnation and not merely performing poorly after the crisis. Long-term stagnation is a very serious problem as incomes suffer, employment becomes weak, welfare declines, economic instability is exacerbated, and social tensions rise. In the four decades since the early 1970s, the average rate of growth in the USA, Japan, Germany and the UK has fallen from about 4% to about 2%. During the same period a succession of crises has occurred, 1973-5, 1980-2, 1990-92, 2000-2002, and 2007-9, the last three of which were clearly associated with financial bubbles. Meanwhile, labour has dramatically lost to capital as inequality has rocketed. It might not be quite stagnation, but growth has been indifferent and punctuated by bubbles and crises.

Many on the left consider these phenomena to be the result of neoliberalism, i.e., of the dominant ideology of the period, which preaches free markets and advocates deregulation and privatisation. But, deeper processes have been taking place during this period, including a technological revolution and the spreading of part-time and insecure employment. These profound changes have increased the productivity of labour, but nothing like previous historical periods. Despite rosy expectations, information technology has proven inferior in this regard to, say, electricity or the internal combustion engine.

New technology and altered work practices, on the other hand, have been exceptionally effective at propelling finance forward. Aided by financial deregulation, they have transformed the way banks and financial markets operate, facilitating remarkable growth. The most striking aspect of the last four decades is the asymmetry between the real and the financial sector of mature economies. Finance has ballooned, providing new sources of enormous profits, fostering inequality, blowing huge bubbles and exacerbating crises, while production has performed indifferently. Even more tellingly, the practices, outlook and morality of finance have penetrated the rest of the economy.

In short, mature capitalism has become financialised: industrial and commercial enterprises sit on huge amounts of money, which they are reluctant to invest but use instead to generate financial profit; banks lend less for production, seek profits in financial trading, and feed one bubble after the next; households have become enormously indebted as well as relying on private financial institutions for pensions. The failure of contemporary capitalism to produce sustained growth is related to its financialisation, and not to the inability of interest rates to fall below zero.

There are policies that could improve things in the short term, including regulation of the financial system, redistributing income and wealth in favour of workers, and expanding public expenditure. In this way, production could be expected to recover, living standards to improve and tax income to rise balancing the books of the state. But the real challenge is to achieve structural change reversing financialisation, a task that requires inherently anti-capitalist measures. They include wholesale restoration of public welfare provision and reintroduction of public ownership, with a fresh mandate and spirit, in both the real and the financial sector. The long-term choice for mature societies is either to continue with disastrous financialisation, or to follow an inherently anti-capitalist path.