C.7 What causes the capitalist business cycle?

The business cycle is the term used to describe the boom and slump nature of capitalism. Sometimes there is full employment, with workplaces producing more and more goods and services, the economy grows and along with it wages. However, as Proudhon argued, this happy situation does not last:

"But industry, under the influence of property, does not proceed with such regularity. . . As soon as a demand begins to be felt, the factories fill up, and everybody goes to work. Then business is lively. . . Under the rule of property, the flowers of industry are woven into none but funeral wreaths. The labourer digs his own grave. . . [the capitalist] tries. . . to continue production by lessening expenses. Then comes the lowering of wages; the introduction of machinery; the employment of women and children . . . the decreased cost creates a larger market. . . [but] the productive power tends to more than ever outstrip consumption. . . To-day the factory is closed. Tomorrow the people starve in the streets. . . In consequence of the cessation of business and the extreme cheapness of merchandise. . . frightened creditors hasten to withdraw their funds [and] Production is suspended, and labour comes to a standstill." [P-J Proudhon, What is Property, pp. 191-192]

Why does this happen? For anarchists, as Proudhon noted, it's to do with the nature of capitalist production and the social relationships it creates ("the rule of property"). The key to understanding the business cycle is to understand that, to use Proudhon's words, "Property sells products to the labourer for more than it pays him for them; therefore it is impossible." [Op. Cit., p. 194] In other words, the need for the capitalist to make a profit from the workers they employ is the underlying cause of the business cycle. If the capitalist class cannot make enough profit, then it will stop production, sack people, ruin lives and communities until such as enough profit can again be extracted from the workers.

So what influences this profit level? There are two main classes of pressure on profits, what we will call the "subjective" and "objective." The objective pressures are related to what Proudhon termed the fact that "productive power tends more and more to outstrip consumption" and are discussed in sections C.7.2 and C.7.3. The "subjective" pressures are to do with the nature of the social relationships created by capitalism, the relations of domination and subjection which are the root of exploitation and the resistance to them. In other words the subjective pressures are the result of the fact that "property is despotism" (to use Proudhon's expression). We will discuss the impact of the class struggle (the "subjective" pressure) in the next section.

Before continuing, we would like to stress here that all three factors operate together in a real economy and we have divided them purely to help explain the issues involved in each one. The class struggle, market "communication" creating disproportionalities and over-investment all interact. Due to the needs of the internal (class struggle) and external (inter-company) competition, capitalists have to invest in new means of production. As workers' power increase during a boom, capitalists innovate and invest in order to try and counter it. Similarly, to get market advantage (and so increased profits) over their competitors, a company invests in new machinery. However, due to lack of effective communication within the market caused by the price mechanism and incomplete information provided by the interest rate, this investment becomes concentrated in certain parts of the economy. Relative over-investment can occur, creating the possibility of crisis. In addition, the boom encourages new companies and foreign competitors to try and get market share, so decreasing the "degree of monopoly" in an industry, and so reducing the mark-up and profits of big business (which, in turn, can cause an increase in mergers and take-overs towards the end of the boom). Meanwhile, workers power is increasing, causing profit margins to be eroded, but also reducing tendencies to over-invest by resisting the introduction of new machinery and technics and by maintaining demand for the finished goods. This contradictory effect of class struggle matches the contradictory effect of investment. Just as investment causes crisis because it is useful (i.e. it helps increase profits for individual companies in the short term, but it leads to collective over-investment and falling profits in the long term), the class struggle both hinders over-accumulation of capital and maintains aggregate demand (so postponing the crisis) while at the same time eroding profit margins at the point of production (so accelerating it). Thus subjective and objective factors interact and counteract with each other, but in the end a crisis will result simply because the system is based upon wage labour and the producers are not producing for themselves. Ultimately, a crisis is caused when the capitalist class does not get a sufficient rate of profit. If workers produced for themselves, this decisive factor would not be an issue as no capitalist class would exist.

And we should note that these factors work in reverse during a slump, creating the potential for a boom. During a crisis, capitalists still try to improve their profitability (i.e. increase surplus value). Labour is in a weak position due to the large rise in unemployment and so, usually, accept the increased rate of exploitation this implies to remain in work. In the slump, many firms go out of business, so reducing the amount of fixed capital in the economy. In addition, as firms go under the "degree of monopoly" of each industry increases, which increases the mark-up and profits of big business. Eventually this increased surplus value production is enough relative to the (reduced) fixed capital stock to increase the rate of profit. This encourages capitalists to start investing again and a boom begins (a boom which contains the seeds of its own end).

And so the business cycle continues, driven by "subjective" and "objective" pressures -- pressures that are related directly to the nature of capitalist production and the wage labour on which it is based.

C.7.1 What role does class struggle play in the business cycle?

At its most basic, the class struggle (the resistance to hierarchy in all its forms) is the main cause of the business cycle. As we argued in section B.1.2 and section C.2, capitalists in order to exploit a worker must first oppress them. But where there is oppression, there is resistance; where there is authority, there is the will to freedom. Hence capitalism is marked by a continuous struggle between worker and boss at the point of production as well as struggle outside of the workplace against other forms of hierarchy.

This class struggle reflects a conflict between workers attempts at liberation and self-empowerment and capitals attempts to turn the individual worker into a small cog in a big machine. It reflects the attempts of the oppressed to try to live a fully human life, expressed when the "worker claims his share in the riches he produces; he claims his share in the management of production; and he claims not only some additional well-being, but also his full rights in the higher enjoyment of science and art." [Peter Kropotkin, Kropotkin's Revolutionary Pamphlets, pp. 48-49]

As Errico Malatesta argued, if workers "succeed in getting what they demand, they will be better off: they will earn more, work fewer hours and will have more time and energy to reflect on things that matter to them, and will immediately make greater demands and have greater needs. . . [T]here exists no natural law (law of wages) which determines what part of a worker's labour should go to him [or her]. . . Wages, hours and other conditions of employment are the result of the struggle between bosses and workers. The former try and give the workers as little as possible; the latter try, or should try to work as little, and earn as much, as possible. Where workers accept any conditions, or even being discontented, do not know how to put up effective resistance to the bosses demands, they are soon reduced to bestial conditions of life. Where, instead, they have ideas of how human beings should live and know how to join forces, and through refusal to work or the latent and open threat of rebellion, to win bosses respect, in such cases, they are treated in a relatively decent way. . . Through struggle, by resistance against the bosses, therefore, workers can, up to a certain point, prevent a worsening of their conditions as well as obtaining real improvement." [Life and Ideas, pp. 191-2]

It is this struggle that determines wages and indirect income such as welfare, education grants and so forth. This struggle also influences the concentration of capital, as capital attempts to use technology to control workers (and so extract the maximum surplus value possible from them) and to get an advantage against their competitors (see section C.2.3). And, as will be discussed in section D.10 ( How does capitalism affect technology?), increased capital investment also reflects an attempt to increase the control of the worker by capital (or to replace them with machinery that cannot say "no") plus the transformation of the individual into "the mass worker" who can be fired and replaced with little or no hassle. For example, Proudhon quotes an "English Manufacturer" who states that he invested in machinery precisely to replace humans by machines because machines are easier to control:

"The insubordination of our workforce has given us the idea of dispensing with them. We have made and stimulated every imaginable effort of the mind to replace the service of men by tools more docile, and we have achieved our object. Machinery has delivered capital from the oppression of labour." [System of Economical Contradictions, p. 189]

(To which Proudhon replied "[w]hat a misfortunate that machinery cannot also deliver capital from the oppression of consumers!" as the over-production and inadequate market caused by machinery replacing people soon destroys these illusions of automatic production by a slump -- see section C.7.3).

Therefore, class struggle influences both wages and capital investment, and so the prices of commodities in the market. It also, more importantly, determines profit levels and it is profit levels that are the cause of the business cycle. This is because, under capitalism, production's "only aim is to increase the profits of the capitalist. And we have, therefore, - the continuous fluctuations of industry, the crisis coming periodically. . . " [Kropotkin, Op. Cit., p. 55]

A common capitalist myth, derived from the capitalist Subjective Theory of Value, is that free-market capitalism will result in a continuous boom, since the cause of slumps is allegedly state control of credit and money. Let us assume, for a moment, that this is the case. (In fact, it is not the case, as will be highlighted in section C.8). In the "boom economy" of "free market" dreams, there will be full employment. But in a period of full employment, while it helps "increase total demand, its fatal characteristic from the business view is that it keeps the reserve army of the unemployed low, thereby protecting wage levels and strengthening labour's bargaining power." [Edward S. Herman, Beyond Hypocrisy, p. 93]

In other words, workers are in a very strong position under boom conditions, a strength which can undermine the system. This is because capitalism always proceeds along a tightrope. If a boom is to continue smoothly, real wages must develop within a certain band. If their growth is too low then capitalists will find it difficult to sell the products their workers have produced and so, because of this, face what is often called a "realisation crisis" (i.e. the fact that capitalists cannot make a profit if they cannot sell their products). If real wage growth is too high then the conditions for producing profits are undermined as labour gets more of the value it produces. This means that in periods of boom, when unemployment is falling, the conditions for realisation improve as demand for consumer goods increase, thus expanding markets and encouraging capitalists to invest. However, such an increase in investment (and so employment) has an adverse effect on the conditions for producing surplus value as labour can assert itself at the point of production, increase its resistance to the demands of management and, far more importantly, make its own.

If an industry or country experiences high unemployment, workers will put up with longer hours, stagnating wages, worse conditions and new technology in order to remain in work. This allows capital to extract a higher level of profit from those workers, which in turn signals other capitalists to invest in that area. As investment increases, unemployment falls. As the pool of available labour runs dry, then wages will rise as employers bid for scare resources and workers feel their power. As workers are in a better position they can go from resisting capital's agenda to proposing their own (e.g. demands for higher wages, better working conditions and even for workers' control). As workers' power increases, the share of income going to capital falls, as do profit rates, and capital experiences a profits squeeze and so cuts down on investment and employment and/or wages. The cut in investment increases unemployment in the capital goods sector of the economy, which in turn reduces demand for consumption goods as jobless workers can no longer afford to buy as much as before. This process accelerates as bosses fire workers or cut their wages and the slump deepens and so unemployment increases, which begins the cycle again. This can be called "subjective" pressure on profit rates.

This interplay of profits and wages can be seen in most business cycles. As an example, let's consider the crisis which ended post-war Keynesianism in the early 1970's and paved the way for the "supply side revolutions" of Thatcher and Reagan. This crisis, which occurred in 1973, had its roots in the 1960s boom. If we look at the USA we find that it experienced continuous growth between 1961 and 1969 (the longest in its history). From 1961 onwards, unemployment steadily fell, effectively creating full employment. From 1963, the number of strikes and total working time lost steadily increased (from around 3000 strikes in 1963 to nearly 6000 in 1970). The number of wildcat strike rose from 22% of all strikes in 1960 to 36.5% in 1966. By 1965 both the business profit shares and business profit rates peaked. The fall in profit share and rate of profit continued until 1970 (when unemployment started to increase), where it rose slightly until the 1973 slump occurred, In addition, after 1965, inflation started to accelerate as capitalist firms tried to maintain their profit margins by passing cost increases to consumers (as we discuss below, inflation has far more to do with capitalist profits than it has with money supply or wages). This helped to reduce real wage gains and maintain profitability over the 1968 to 1973 period above what it otherwise would have been, which helped postpone, but not stop, a slump.

Looking at the wider picture, we find that for the advanced capital countries as a whole, the product wage rose steadily between 1962 and 1971 while productivity fell. The product wage (the real cost to the employer of hiring workers) meet that of productivity in 1965 (at around 4%) -- which was also the year in which profit share in income and the rate of profit peaked . From 1965 to 1971, productivity continued to fall while the product wage continued to rise. This process, the result of falling unemployment and rising workers' power (expressed, in part, by an explosion in the number of strikes across Europe and elsewhere), helped to ensure that the actual post-tax real wages and productivity in a the advanced capitalist countries increased at about the same rate from 1960 to 1968 (4%). But between 1968 and 1973, post-tax real wages increased by an average of 4.5% compared to a productivity rise of only 3.4%. Moreover, due to increased international competition companies could not pass on wage rises to consumers in the form of higher prices (which, again, would only have postponed, but not stopped, the slump). As a result of these factors, the share of profits going to business fell by about 15% in that period.

In addition, outside the workplace a "series of strong liberation movements emerged among women, students and ethnic minorities. A crisis of social institutions was in progress, and large social groups were questioning the very foundations of the modern, hierarchical society: the patriarchal family, the authoritarian school and university, the hierarchical workplace or office, the bureaucratic trade union or party." [Takis Fotopoulos, "The Nation-state and the Market," p. 58, Society and Nature, Vol. 3, pp. 44-45]

These social struggles resulted in an economic crisis as capital could no longer oppress and exploit working class people sufficiently in order to maintain a suitable profit rate. This crisis was then used to discipline the working class and restore capitalist authority within and without the workplace (see section C.8.2). We should also note that this process of social revolt in spite, or perhaps because of, the increase of material wealth was predicted by Malatesta. In 1922 he argued that:

"The fundamental error of the reformists is that of dreaming of solidarity, a sincere collaboration, between masters and servants. . .

"Those who envisage a society of well stuffed pigs which waddle contentedly under the ferule of a small number of swineherd; who do not take into account the need for freedom and the sentiment of human dignity. . . can also imagine and aspire to a technical organisation of production which assures abundance for all and at the same time materially advantageous both to bosses and the workers. But in reality 'social peace' based on abundance for all will remain a dream, so long as society is divided into antagonistic classes, that is employers and employees. . .

"The antagonism is spiritual rather than material. There will never be a sincere understanding between bosses and workers for the better exploitation [sic!] of the forces of nature in the interests of mankind, because the bosses above all want to remain bosses and secure always more power at the expense of the workers, as well as by competition with other bosses, whereas the workers have had their fill of bosses and don't want more!" [Life and Ideas, pp. 78-79]

The experience of the post-war compromise and social democratic reform indicates well that, ultimately, the social question is not poverty but rather freedom. However, to return to the impact of class struggle on capitalism.

More recently, the panics in Wall Street that accompany news that unemployment is dropping in the USA reflect this fear of working class power. Without the fear of unemployment, workers may start to fight for improvements in their conditions, against capitalist oppression and exploitation and for liberty and a just world. Every slump within capitalism has occurred when workers have seen unemployment fall and their living standards improve -- not a coincidence.

The Philips Curve, which indicates that inflation rises as employment falls is also an indication of this relationship. Inflation is the situation when there is a general rise in prices. Neo-classical (and other pro-"free market" capitalist) economics argue that inflation is purely a monetary phenomenon, the result of there being more money in circulation than is needed for the sale of the various commodities on the market. However, this is not true. In general, there is no relationship between the money supply and inflation. The amount of money can increase while the rate of inflation falls, for example (as was the case in the USA between 1975 and 1984). Inflation has other roots, namely it is "an expression of inadequate profits that must be offset by price and money policies. . . Under any circumstances, inflation spells the need for higher profits. . ." [Paul Mattick, Economics, Politics and the Age of Inflation, p. 19] Inflation leads to higher profits by making labour cheaper. That is, it reduces "the real wages of workers. . . [which] directly benefits employers. . . [as] prices rise faster than wages, income that would have gone to workers goes to business instead." [J. Brecher and T. Costello, Common Sense for Hard Times, p. 120]

Inflation, in other words, is a symptom of an on-going struggle over income distribution between classes and, as workers do not have any control over prices, it is caused when capitalist profit margins are reduced (for whatever reason, subjective or objective). This means that it would be wrong to conclude that wage increases "cause" inflation as such. To do so ignores the fact that workers do not set prices, capitalists do. Inflation, in its own way, shows the hypocrisy of capitalism. After all, wages are increasing due to "natural" market forces of supply and demand. It is the capitalists who are trying to buck the market by refusing to accept lower profits caused by conditions on that market. Obviously, to use Tucker's expression, under capitalism market forces are good for the goose (labour) but bad for the gander (capital).

This does not mean that inflation suits all capitalists equally (nor, obviously, does it suit those social layers who live on fixed incomes and who thus suffer when prices increase but such people are irrelevant in the eyes of capital). Far from it - during periods of inflation, lenders tend to lose and borrowers tend to gain. The opposition to high levels of inflation by many supporters of capitalism is based upon this fact and the division within the capitalist class it indicates. There are two main groups of capitalists, finance capitalists and industrial capitalists. The latter can and do benefit from inflation (as indicated above) but the former sees high inflation as a threat. When inflation is accelerating it can push the real interest rate into negative territory and this is a horrifying prospect to those for whom interest income is fundamental (i.e. finance capital). In addition, high levels of inflation can also fuel social struggle, as workers and other sections of society try to keep their income at a steady level. As social struggle has a politicising effect on those involved, a condition of high inflation could have serious impacts on the political stability of capitalism and so cause problems for the ruling class.

How inflation is viewed in the media and by governments is an expression of the relative strengths of the two sections of the capitalist class and of the level of class struggle within society. For example, in the 1970s, with the increased international mobility of capital, the balance of power came to rest with finance capital and inflation became the source of all evil. This shift of influence to finance capital can be seen from the rise of rentier income. The distribution of US manufacturing profits indicate this process -- comparing the periods 1965-73 to 1990-96, we find that interest payments rose from 11% to 24%, dividend payments rose from 26% to 36% while retained earnings fell from 65% to 40% (given that retained earnings are the most important source of investment funds, the rise of finance capital helps explain why, in contradiction to the claims of the right-wing, economic growth has become steadily worse as markets have been liberalised -- funds that would have been resulted in real investment have ended up in the finance machine). In addition, the waves of strikes and protests that inflation produced had worrying implications for the ruling class. However, as the underlying reasons for inflation remained (namely to increase profits) inflation itself was only reduced to acceptable levels, levels that ensured a positive real interest rate and acceptable profits.

It is the awareness that full employment is bad for business which is the basis of the so-called "Non-Accelerating Inflation Rate of Unemployment" (NAIRU). This is the rate of unemployment for an economy under which inflation, it is claimed, starts to accelerate. While the basis of this "theory" is slim (the NAIRU is an invisible, mobile rate and so the "theory" can explain every historical event simply because you can prove anything when your datum cannot be seen by mere mortals) it is very useful for justifying policies which aim at attacking working people, their organisations and their activities. The NAIRU is concerned with a "wage-price" spiral caused by falling unemployment and rising workers' rights and power. Of course, you never hear of an "interest-price" spiral or a "rent-price" spiral or a "profits-price" spiral even though these are also part of any price. It is always a "wage-price" spiral, simply because interest, rent and profits are income to capital and so, by definition, above reproach. By accepting the logic of NAIRU, the capitalist system implicitly acknowledges that it and full employment are incompatible and so with it any claim that it allocates resources efficiently or labour contracts benefit both parties equally.

For these reasons, anarchists argue that a continual "boom" economy is an impossibility simply because capitalism is driven by profit considerations, which, combined with the subjective pressure on profits due to the class struggle between workers and capitalists, necessarily produces a continuous boom-and-bust cycle. When it boils down to it, this is unsurprising, as "[o]f necessity, the abundance of some will be based upon the poverty of others, and the straitened circumstances of the greater number will have to be maintained at all costs, that there may be hands to sell themselves for a part only of that which they are capable of producing, without which private accumulation of capital is impossible!" [Kropotkin, Op. Cit., p. 128]

Of course, when such "subjective" pressures are felt on the system, when private accumulation of capital is threatened by improved circumstances for the many, the ruling class denounces working class "greed" and "selfishness." When this occurs we should remember what Adam Smith had to say on this subject:

"In reality high profits tend much more to raise the price of work than high wages. . . That part of the price of the commodity that resolved itself into wages would. . . rise only in arithmetical proportion to the rise in wages. But if profits of all the different employers of those working people should be raised five per cent., that price of the commodity which resolved itself into profit would. . . rise in geometrical proportion to this rise in profit. . . Our merchants and master manufacturers complain of the bad effects of high wages in raising the price and thereby lessening the sale of their goods at home and abroad. They say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people" [The Wealth of Nations, pp. 87-88]

As an aside, we must note that these days we would have to add economists to Smith's "merchants and master manufacturers." Not that this is surprising, given that economic theory has progressed (or degenerated) from Smith's disinterested analysis to apologetics for any action of the boss (a classic example, we must add, of supply and demand, with the marketplace of ideas responding to a demand for such work from "our merchants and master manufacturers"). Any "theory" which blames capitalism's problems on "greedy" workers will always be favoured over one that correctly places them in the contradictions created by wage slavery. Proudhon summed by capitalist economic theory well when he stated that "Political economy -- that is, proprietary despotism -- can never be in the wrong: it must be the proletariat." [System of Economical Contradictions, p. 187] And little has changed since 1846 (or 1776!) when it comes to economics "explaining" capitalism's problems (such as the business cycle or unemployment). Ultimately, capitalist economics blame every problem of capitalism on the working class refusing to kow-tow to the bosses (for example, unemployment is caused by wages being too high rather than bosses needing unemployment to maintain their power and profits -- see section C.9.2 on empirical evidence that indicates that the second explanation is the accurate one).

Before concluding, one last point. While it may appear that our analysis of the "subjective" pressures on capitalism is similar to that of mainstream economics, this is not the case. This is because our analysis recognises that such pressures are inherent in the system, have contradictory effects (and so cannot be easily solved without making things worse before they get better) and hold the potential for creating a free society. Our analysis recognises that workers' power and resistance is bad for capitalism (as for any hierarchical system), but it also indicates that there is nothing capitalism can do about it without creating authoritarian regimes (such as Nazi Germany) or by generating massive amounts of unemployment (as was the case in the early 1980s in both the USA and the UK, when right-wing governments deliberately caused deep recessions) and even this is no guarantee of eliminating working class struggle as can be seen, for example, from 1930s America or 1970s Britain.

This means that our analysis shows the limitations and contradictions of the system as well as its need for workers to be in a weak bargaining position in order for it to "work" (which explodes the myth that capitalism is a free society). Moreover, rather than portray working people as victims of the system (as is the case in many Marxist analyses of capitalism) our analysis recognises that we, both individually and collectively, have the power to influence and change that system by our activity. We should be proud of the fact that working people refuse to negate themselves or submit their interests to that of others or play the role of order-takers required by the system. Such expressions of the human spirit, of the struggle of freedom against authority, should not be ignored or down-played, rather they should be celebrated. That the struggle against authority causes the system so much trouble is not an argument against social struggle, it is an argument against a system based on hierarchy, exploitation and the denial of freedom.

To sum up, in many ways, social struggle is the inner dynamic of the system, and its most basic contradiction: while capitalism tries to turn the majority of people into commodities (namely, bearers of labour power), it also has to deal with the human responses to this process of objectification (namely, the class struggle). However, it does not follow that cutting wages will solve a crisis -- far from it, for, as we argue in section C.9.1, cutting wages will deepen any crisis, making things worse before they get better. Nor does it follow that, if social struggle were eliminated, capitalism would work fine. After all, if we assume that labour power is a commodity like any other, its price will rise as demand increases relative to supply (which will either produce inflation or a profits squeeze, probably both). Therefore, even without the social struggle which accompanies the fact that labour power cannot be separated from the individuals who sell it, capitalism would still be faced with the fact that only surplus labour (unemployment) ensures the creation of adequate amounts of surplus value.

Moreover, even assuming that individuals can be totally happy in a capitalist economy, willing to sell their freedom and creativity for a little money, putting up, unquestioningly, with every demand and whim of their bosses (and so negating their own personality and individuality in the process), capitalism does have "objective" pressures limiting its development. So while social struggle, as argued above, can have a decisive effect on the health of the capitalist economy, it is not the only problems the system faces. This is because there are objective pressures within the system beyond and above the authoritarian social relations it produces (and the resistance to them). These pressures are discussed next, in sections C.7.2 and C.7.3.

C.7.2 What role does the market play in the business cycle?

A major problem with capitalism is the working of the capitalist market itself. For the supporters of "free market" capitalism, the market provides all the necessary information required to make investment and production decisions. This means that a rise or fall in the price of a commodity acts as a signal to everyone in the market, who then respond to that signal. These responses will be co-ordinated by the market, resulting in a healthy economy. For example, a rise in the price of a commodity will result in increased production and reduced consumption of that good, and this will move the economy towards equilibrium.

While it can be granted that this account of the market is not without foundation, its also clear that the price mechanism does not communicate all the relevant information needed by companies or individuals. This means that capitalism does not work in the way suggested in the economic textbooks. It is the workings of the price mechanism itself which leads to booms and slumps in economic activity and the resulting human and social costs they entail. This can be seen if we investigate the actual processes hidden behind the workings of the price mechanism.

When individuals and companies make plans concerning future production, they are planning not with respect of demand now but with respect to expected demand at some future time when their products reach the market. The information the price mechanism provides, however, is the relation of supply and demand (or market price with respect to the market production price) at the current time. While this information is relevant to people's plans, it is not all the information that is relevant or is required by those involved.

The information which the market does not provide is that of the plans of other people's reactions to the supplied information. This information, moreover, cannot be supplied due to competition. Simply put, if A and B are in competition, if A informs B of her activities and B does not reciprocate, then B is in a position to compete more effectively than A. Hence communication within the market is discouraged and each production unit is isolated from the rest. In other words, each person or company responds to the same signal (the change in price) but each acts independently of the response of other producers and consumers. The result is often a slump in the market, causing unemployment and economic disruption.

For example, lets assume a price rise due to a shortage of a commodity. This results in excess profits in that market, leading the owners of capital to invest in this branch of production in order to get some of these above-average profits. However, consumers will respond to the price rise by reducing their consumption of that good. This means that when the results of these independent decisions are realised, there is an overproduction of that good in the market in relation to effective demand for it. Goods cannot be sold and so there is a realisation crisis as producers cannot make a profit from their products. Given this overproduction, there is a slump, capital disinvests, and the market price falls. This eventually leads to a rise in demand against supply, production expands leading to another boom and so on.

Proudhon described this process as occurring because of the "contradiction" of "the double character of value" (i.e. between value in use and value in exchange). This contradiction results in a good's "value decreas[ing] as the production of utility increases, and a producer may arrive at poverty by continually enriching himself" via over-production. This is because a producer "who has harvested twenty sacks of wheat. . . believes himself twice as rich as if he had harvested only ten. . . Relatively to the household, [they] are right; looked at in their external relations, they may be utterly mistaken. If the crop of wheat is double throughout the whole country, twenty sacks will sell for less than ten would have sold for if it had been as half as great." [The System of Economical Contradictions, p. 78, pp. 77-78]

This, it should be noted, is not a problem of people making a series of unrelated mistakes. Rather, it results because the market imparts the same information to all involved and this information is not sufficient for rational decision making. While it is rational for each agent to expand or contract production, it is not rational for all agents to act in this manner. In a capitalist economy, the price mechanism does not supply all the information needed to make rational decisions. In fact, it actively encourages the suppression of the needed extra information concerning the planned responses to the original information.

It is this irrationality and lack of information which feed into the business cycle. These local booms and slumps in production of the kind outlined here can then be amplified into general crises due to the insufficient information spread through the economy by the market. However, disproportionalities of capital between industries do not per se result in a general crisis. If this was that case the capitalism would be in a constant state of crisis because capital moves between markets during periods of prosperity as well as just before periods of depression. This means that market dislocations cannot be a basis for explaining the existence of a general crisis in the economy (although it can and does explain localised slumps).

Therefore, the tendency to general crisis that expresses itself in a generalised glut on the market is the product of deeper economic changes. While the suppression of information by the market plays a role in producing a depression, a general slump only develops from a local boom and slump cycle when it occurs along with the second side-effect of capitalist economic activity, namely the increase of productivity as a result of capital investment, as well as the subjective pressures of class struggle.

The problems resulting from increased productivity and capital investment are discussed in the next section.

C.7.3 What role does investment play in the business cycle?

Other problems for capitalism arise due to increases in productivity which occur as a result of capital investment or new working practices which aim to increase short term profits for the company. The need to maximise profits results in more and more investment in order to improve the productivity of the workforce (i.e. to increase the amount of surplus value produced). A rise in productivity, however, means that whatever profit is produced is spread over an increasing number of commodities. This profit still needs to be realised on the market but this may prove difficult as capitalists produce not for existing markets but for expected ones. As individual firms cannot predict what their competitors will do, it is rational for them to try to maximise their market share by increasing production (by increasing investment). As the market does not provide the necessary information to co-ordinate their actions, this leads to supply exceeding demand and difficulties realising the profits contained in the produced commodities. In other words, a period of over-production occurs due to the over-accumulation of capital.

Due to the increased investment in the means of production, variable capital (labour) uses a larger and larger constant capital (the means of production). As labour is the source of surplus value, this means that in the short term profits must be increased by the new investment, i.e. workers must produce more, in relative terms, than before so reducing a firms production costs for the commodities or services it produces. This allows increased profits to be realised at the current market price (which reflects the old costs of production). Exploitation of labour must increase in order for the return on total (i.e. constant and variable) capital to increase or, at worse, remain constant.

However, while this is rational for one company, it is not rational when all firms do it, which they must in order to remain in business. As investment increases, the surplus value workers have to produce must increase faster. If the mass of available profits in the economy is too small compared to the total capital invested then any problems a company faces in making profits in a specific market due to a localised slump caused by the price mechanism may spread to affect the whole economy. In other words, a fall in the rate of profit (the ratio of profit to investment in capital and labour) in the economy as a whole could result in already produced surplus value, earmarked for the expansion of capital, remaining in its money form and thus failing to act as capital. No new investments are made, goods cannot be sold resulting in a general reduction of production and so increased unemployment as companies fire workers or go out of business. This removes more and more constant capital from the economy, increasing unemployment which forces those with jobs to work harder, for longer so allowing the mass of profits produced to be increased, resulting (eventually) in an increase in the rate of profit. Once profit rates are high enough, capitalists have the incentive to make new investments and slump turns to boom.

It could be argued that such an analysis is flawed as no company would invest in machinery if it would reduce it's rate of profit. But such an objection is flawed, simply because (as we noted) such investment is perfectly sensible (indeed, a necessity) for a specific firm. By investing they gain (potentially) an edge in the market and so increased profits. Unfortunately, while this is individually sensible, collectively it is not as the net result of these individual acts is over-investment in the economy as a whole. Unlike the model of perfect competition, in a real economy capitalists have no way of knowing the future, and so the results of their own actions, nevermind the actions of their competitors. Thus over-accumulation of capital is the natural result of competition simply because it is individually rational and the future is unknowable. Both of these factors ensure that firms act as they do, investing in machinery which, in the end, will result in a crisis of over-accumulation.

Cycles of prosperity, followed by over-production and then depression are the natural result of capitalism. Over-production is the result of over-accumulation, and over-accumulation occurs because of the need to maximise short-term profits in order to stay in business. So while the crisis appears as a glut of commodities on the market, as there are more commodities in circulation that can be purchased by the aggregate demand ("Property sells products to the labourer for more than it pays him for them," to use Proudhon's words), its roots are deeper. It lies in the nature of capitalist production itself.

A classic example of these "objective" pressures on capitalism is the "Roaring Twenties" that preceded the Great Depression of the 1930s. After the 1921 slump, there was a rapid rise in investment in the USA with investment nearly doubling between 1919 and 1927.

Because of this investment in capital equipment, manufacturing production grew by 8.0% per annum between 1919 and 1929 and labour productivity grew by an annual rate of 5.6% (this is including the slump of 1921-22). This increase in productivity was reflected in the fact that over the post-1922 boom, the share of manufacturing income paid in salaries rose from 17% to 18.3% and the share to capital rose from 25.5% to 29.1%. Managerial salaries rose by 21.9% and firm surplus by 62.6% between 1920 and 1929. With costs falling and prices comparatively stable, profits increased which in turn lead to high levels of capital investment (the production of capital goods increased at an average annual rate of 6.4%).

Unsurprisingly, in such circumstances, in the 1920s prosperity was concentrated at the top 60% of families made less than $2000 a year, 42% less than $1000. One-tenth of the top 1% of families received as much income as the bottom 42% and only 2.3% of the population enjoyed incomes over $10000. While the richest 1% owned 40% of the nation's wealth by 1929 (and the number of people claiming half-million dollar incomes rose from 156 in 1920 to 1489 in 1929) the bottom 93% of the population experienced a 4% drop in real disposable per-capita income between 1923 and 1929.

However, in spite of this, US capitalism was booming and the laissez-faire capitalism was at its peak. But by 1929 all this had changed with the stock market crashing -- followed by a deep depression. What was its cause? Given our analysis presented above, it may have been expected to have been caused by the "boom" decreasing unemployment, so increased working class power and leading to a profits squeeze, but this was not the case.

This slump was not the result of working class resistance, indeed the 1920s were marked by a labour market which remained continuously favourable to employers. This was for two reasons. Firstly, the "Palmer Raids" at the end of the 1910s saw the state root out radicals in the US labour movement and wider society. Secondly, the deep depression of 1920-21 (during which national unemployment rates averaged over 9%) combined with the use of legal injunctions by employers against work protests and the use of industrial spies to identify and sack union members made labour weak and so the influence and size of unions fell as workers were forced to sign "yellow-dog" contracts to keep their jobs.

During the post-1922 boom, this position did not change. The national 3.3% unemployment rate hid the fact that non-farm unemployment averaged 5.5% between 1923 and 1929. Across all industries, the growth of manufacturing output did not increase the demand for labour. Between 1919 and 1929, employment of production workers fell by 1% and non-production employment fell by about 6% (during the 1923 to 29 boom, production employment only increased by 2%, and non-production employment remained constant). This was due to the introduction of labour saving machinery and the rise in the capital stock. In addition, the high productivity associated with farming resulted in a flood of rural workers into the urban labour market.

Facing high unemployment, workers' quit rates fell due to fear of loosing jobs (particularly those workers with relatively higher wages and employment stability). This combined with the steady decline of the unions and the very low number of strikes (lowest since the early 1880s) indicates that labour was weak. Wages, like prices, were comparatively stable. Indeed, the share of total manufacturing income going to wages fell from 57.5% in 1923-24 to 52.6% in 1928/29 (between 1920 and 1929, it fell by 5.7%). It is interesting to note that even with a labour market favourable to employers for over 5 years, unemployment was still high. This suggests that the neo-classical "argument" that unemployment within capitalism is caused by strong unions or high real wages is somewhat flawed to say the least (see section C.9).

The key to understanding what happened lies the contradictory nature of capitalist production. The "boom" conditions were the result of capital investment, which increased productivity, thereby reducing costs and increasing profits. The large and increasing investment in capital goods was the principal device by which profits were spent. In addition, those sectors of the economy marked by big business (i.e. oligopoly, a market dominated by a few firms) placed pressures upon the more competitive ones. As big business, as usual, received a higher share of profits due to their market position (see section C.5), this lead to many firms in the more competitive sectors of the economy facing a profitability crisis during the 1920s.

The increase in investment, while directly squeezing profits in the more competitive sectors of the economy, also eventually caused the rate of profit to stagnate, and then fall, over the economy as a whole. While the mass of available profits in the economy grew, it eventually became too small compared to the total capital invested. Moreover, with the fall in the share of income going to labour and the rise of inequality, aggregate demand for goods could not keep up with production, leading to unsold goods (which is another way of expressing the process of over-investment leading to over-production, as over-production implies under-consumption and vice versa). As expected returns (profitability) on investments hesitated, a decline in investment demand occurred and so a slump began (rising predominantly from the capital stock rising faster than profits). Investment flattened out in 1928 and turned down in 1929. With the stagnation in investment, a great speculative orgy occurred in 1928 and 1929 in an attempt to enhance profitability. This unsurprisingly failed and in October 1929 the stock market crashed, paving the way for the Great Depression of the 1930s.

The crash of 1929 indicates the "objective" limits of capitalism. Even with a very weak position of labour, crisis still occurred and prosperity turned to "hard times." In contradiction to neo-classical economic theory, the events of the 1920s indicate that even if the capitalist assumption that labour is a commodity like all others is approximated in real life, capitalism is still subject to crisis (ironically, a militant union movement in the 1920s would have postponed crisis by shifting income from capital to labour, increasing aggregate demand, reducing investment and supporting the more competitive sectors of the economy!). Therefore, any neo-classical "blame labour" arguments for crisis (which were so popular in the 1930s and 1970s) only tells half the story (if that). Even if workers do act in a servile way to capitalist authority, capitalism will still be marked by boom and bust (as shown by the 1920s and 1980s).

To take another example, America's 100 largest firms, employing 5 million persons and having assets of $126 billion, saw their average amount of assets per worker grow from $12,200 in 1949 to $20,900 in 1959 and to $24,000 in 1962. [First National City Bank, Economic Letter, June 1963]. As can be seen, the rate of increase in average assets per worker falls off over time. The initial period of high capital formation was followed by a recessionary period between 1957 and 1961. These years were marked by a sharp increase in unemployment (from 3 million in 1956 to a high of 5 million in 1961) and a higher unemployment rate after the slump than before (an increase of 1 million from 1956 figures to around 4 million in 1962). [T. Brecher and T. Costello, Common Sense for Hard Times, chart 2]

We have referred to data from this period, because some supporters of "free market" capitalism have used the same period to argue for the advantages of capital investment. This data actually indicates, however, that increased capital formation helps to create the potential for recession, because although it increases productivity (and so profits) for a period, it reduces profit rates in the long run because there is a relative scarcity of surplus value in the economy (compared to invested capital). This fall in profit rates is indicated by the decrease in capital formation, which is the point of production in the first place within capitalism, as well as by the increase of unemployment during that period.

So, if the profit rate falls to a level that does not allow capital formation to continue, a slump sets in. This general slump is usually started by overproduction for a specific commodity, possibly caused by the process described in section C.7.2. If there are enough profits in the economy, localised slumps have a reduced tendency to grow and become general. A slump only becomes general when the rate of profit over the whole economy falls. A local slump spreads through the market because of the lack of information the market provides producers. When one industry over-produces, it cuts back production, introduces cost-cutting measures, fires workers and so on in order to try and realise more profits. This reduces demand for industries that supplied the affected industry and reduces general demand due to unemployment. The related industries now face over-production themselves and the natural response to the information supplied by the market is for individual companies to reduce production, fire workers, etc., which again leads to declining demand. This makes it even harder to realise profit on the market and leads to more cost cutting, deepening the crisis. While individually this is rational, collectively it is not and so soon all industries face the same problem. A local slump is propagated through the economy because the capitalist economy does not communicate enough information for producers to make rational decisions or co-ordinate their activities.

"Over-production," we should point out, exists only from the viewpoint of capital, not of the working class:

"What economists call over-production is but a production that is above the purchasing power of the worker. . . this sort of over-production remains fatally characteristic of the present capitalist production, because workers cannot buy with their salaries what they have produced and at the same time copiously nourish the swarm of idlers who live upon their work." [Peter Kropotkin, Op. Cit., pp. 127-128]

In other words, over-production and under-consumption reciprocally imply each other. There is no over production except in regard to a given level of solvent demand. There is no deficiency in demand except in relation to a given level of production. The goods "over-produced" may be required by consumers, but the market price is too low to generate a profit and so production must be reduced in order to artificially increase it. So, for example, the sight of food being destroyed while people go hungry is a common one in depression years.

So, while the crisis appears on the market as a "commodity glut" (i.e. as a reduction in effective demand) and is propagated through the economy by the price mechanism, its roots lie in production. Until such time as profit levels stabilise at an acceptable level, thus allowing renewed capital expansion, the slump will continue. The social costs of such cost cutting is yet another "externality," to be bothered with only if they threaten capitalists' power and wealth.

There are means, of course, by which capitalism can postpone (but not stop) a general crisis developing. Imperialism, by which markets are increased and profits are extracted from less developed countries and used to boost the imperialist countries profits, is one method ("The workman being unable to purchase with their wages the riches they are producing, industry must search for markets elsewhere" - Kropotkin, Op. Cit., p. 55). Another is state manipulation of credit and other economic factors (such as minimum wages, the incorporation of trades unions into the system, arms production, maintaining a "natural" rate of unemployment to keep workers on their toes etc.). Another is state spending to increase aggregate demand, which can increase consumption and so lessen the dangers of over-production. Or the rate of exploitation produced by the new investments can be high enough to counteract the increase in constant capital and keep the profit rate from falling. However, these have (objective and subjective) limits and can never succeed in stopping depressions from occurring.

Hence capitalism will suffer from a boom-and-bust cycle due to the above-mentioned objective pressures on profit production, even if we ignore the subjective revolt against authority by workers, explained earlier. In other words, even if the capitalist assumption that workers are not human beings but only "variable capital" was true, it would not mean that capitalism was a crisis free system. However, for most anarchists, such a discussion is somewhat academic for human beings are not commodities, the labour "market" is not like the iron market, and the subjective revolt against capitalist domination will exist as long as capitalism does.