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<HTML>
<HEAD>

<TITLE>C.8 Is state control of credit the cause of the business cycle?
</TITLE> </HEAD>
<BODY>
<p>

<H1>C.8 Is state control of money the cause of the business cycle? </H1> 
<p>
As explained in the <a href="secC7.html">last section</a>, 
capitalism will suffer from a 
boom-and-bust cycle due to objective pressures on profit 
production, even if we ignore the subjective revolt against
authority by working class people. It is this two-way pressure 
on profit rates, the subjective and objective, which causes the 
business cycle and such economic problems as "stagflation." 
However, for supporters of the free market, this conclusion 
is unacceptable and so they usually try to explain the business 
cycle in terms of <b>external</b> influences rather than those generated
by the way capitalism works. Most pro-"free market" capitalists 
blame government intervention in the market, particularly state 
control over money, as the source of the business cycle. This 
analysis is defective, as will be shown below.
<p>
It should be noted that many supporters of capitalism ignore the
"subjective" pressures on capitalism that we discussed in <a href=
"secC7.html#secc71">section 
C.7.1</a>. In addition, the problems associated with rising capital 
investment (as highlighted in <a href="secC7.html#secc73">section 
C.7.3</a>) are also usually 
ignored, because they usually consider capital to be "productive" 
and so cannot see how its use could result in crises. This leaves 
them with the problems associated with the price mechanism, as 
discussed in <a href="secC7.html#secc72">section C.7.2</a>.
<p>
The idea behind the "state-control-of-money" theory of crises is that
interest rates provide companies and individuals with information about
how price changes will affect future trends in production.  Specifically,
the claim is that changes in interest rates (i.e. changes in the demand
and supply of credit) indirectly inform companies of the responses of
their competitors.  For example, if the price of tin rises, this will lead
to an expansion in investment in the tin industry, so leading to a rise in
interest rates (as more credit is demanded). This rise in interest rates
lowers anticipated profits and dampens the expansion. State control of
money stops this process (by distorting the interest rate) and so results 
in the credit system being unable to perform its economic function. 
This results in overproduction as interest rates do not reflect <b>real</b>
savings and so capitalists over-invest in new capital, capital which
appears profitable only because the interest rate is artificially low.
When the rate inevitably adjusts upwards towards its "real" value, the
invested capital becomes unprofitable and so over-investment appears. 
Hence, according to the argument, by eliminating state control of 
money these negative effects of capitalism would disappear. 
<p>
Before discussing whether state control of money <b>is</b> the cause of
the business cycle, we must point out that the argument concerning
the role of the interest rate does not, in fact, explain the occurrence
of over-investment (and so the business cycle). In other words, the 
explanation of the business cycle as lying in the features of the 
credit system is flawed. This is because it is <b>not</b> clear that the 
<b>relevant</b> information is communicated by changes in interest rates. 
Interest rates reflect the general aggregate demand for credit in 
an economy. However, the information which a <b>specific</b> company 
requires is about the over-expansion in the production of the specific 
good they produce and so the level of demand for credit amongst 
competitors, <b>not</b> the general demand for credit in the economy as 
a whole. An increase in the planned production of some good by a 
group of competitors will be reflected in a proportional change in 
interest rates only if it is assumed that the change in demand for 
credit by that industry is identical with that found in the economy 
as a whole. 
<p>
There is no reason to suppose such an assumption is true, given the
different production cycles of different industries and their differing
needs for credit (in both terms of amount and of intensity). Therefore, 
assuming uneven changes in the demand for credit between industries
reflecting uneven changes in their requirements, it is quite possible 
for over-investment (and so over-production) to occur, even if the 
credit system is working as it should in theory (i.e. the interest 
rate is, in fact, accurately reflecting the <b>real</b> savings available). 
The credit system, therefore, does not communicate the <b>relevant</b> 
information, and for this reason, it cannot be the case that the 
business cycle can be explained by departure from an "ideal system" 
(i.e. laissez-faire capitalism).
<p>
Therefore, it cannot be claimed that removing state-control of money
will also remove the business-cycle. However, the arguments that the
state control of money do have an element of truth in them. Expansion
of credit above the "natural" level which equates it with savings can 
and does allow capital to expand further than it otherwise would and 
so encourages over-investment (i.e. it builds upon trends already present
rather than <b>creating</b> them). While we have ignored the role of credit 
expansion in our comments above to stress that credit is not fundamental
to the business cycle, it is useful to discuss this as it is an essential
factor in real capitalist economies. Indeed, without it capitalist 
economies would not have grown as fast as they have. Credit is 
fundamental to capitalism, in other words.
<p>
There are two main approaches to the question of eliminating state 
control of money in "free market" capitalist economics -- <b>Monetarism</b> 
and what is often called <b>"free banking."</b> We will take each in turn
(a third possible "solution" is to impose a 100% gold reserve
limit for banks, but as this is highly interventionist, and so not
laissez-faire, simply impossible as there is not enough gold to
go round and has all the problems associated with inflexible money
regimes we highlight below, we will not discuss it). 
<p>
Monetarism was very popular in the 1970s and is associated with the
works of Milton Friedman. It is far less radical that the "free banking"

school and argues that rather than abolish state money, its issue should
be controlled. Friedman stressed, like most capitalist economists, that
monetary factors are the important feature in explaining such problems
of capitalism as the business cycle, inflation and so on. This is 
unsurprising, as it has the useful ideological effect of acquitting 
the inner-workings of capitalism of any involvement in such problems.
Slumps, for example, may occur, but they are the fault of the state
interfering in the economy. This is how Friedman explains the Great 
Depression of the 1930s in the USA, for example (see his <i>"The Role 
of Monetary Policy"</i> in <b>American Economic Review</b>, March, 1968).
He also explains inflation by arguing it was a purely monetary
phenomenon caused by the state printing more money than required
by the growth of economic activity (for example, if the economy
grew by 2% but the money supply increased by 5%, inflation would
rise by 3%). This analysis of inflation is deeply flawed, as we
will see.
<p>
Thus Monetarists argued for controlling the money supply, of 
placing the state under a <i>"monetary constitution"</i> which ensured 
that the central banks be required by law to increase the quantity 
of money at a constant rate of 3-5% a year. This would ensure that 
inflation would be banished, the economy would adjust to its natural 
equilibrium, the business cycle would become mild (if not disappear) 
and capitalism would finally work as predicted in the economics 
textbooks. With the <i>"monetary constitution"</i> money would become 
"depoliticised" and state influence and control over money would 
be eliminated. Money would go back to being what it is in 
neo-classical theory, essentially neutral, a link between 
production and consumption and capable of no mischief on its own.
<p>
Unfortunately for Monetarism, its analysis was simply wrong. Even 
more unfortunately for both the theory and vast numbers of people, 
it was proven wrong not only theoretically but also empirically. 
Monetarism was imposed on both the USA and the UK in the early 
1980s, with disastrous results. As the Thatcher government in 1979 
applied Monetarist dogma the most whole-heartedly we will concentrate 
on that regime (the same basic things occurred under Reagan as well). 
<p>
Firstly, the attempt to control the money supply failed, as predicted 
in 1970 by the radical Keynesian Nicholas Kaldor (see his essay 
<i>"The New Monetarism"</i> in <b>Further Essays on Applied Economics</b>, 
for example). This is because the money supply, rather than being set 
by the central bank or the state (as Friedman claimed), is a 
function of the demand for credit, which is itself a function 
of economic activity. To use economic terminology, Friedman had 
assumed that the money supply was <b><i>"exogenous"</i></b> and so determined 
outside the economy by the state when, in fact, it is <b><i>"endogenous"</i></b> 
in nature (i.e. comes from <b>within</b> the economy). This means that 
any attempt to control the money supply will fail. Charles P. 
Kindleburger comments:
<p><blockquote>
<i>"As a historical generalisation, it can be said that every
time the authorities stabilise or control some quantity of
money. . . in moments of euphoria more will be produced. Or
if the definition of money is fixed in terms of particular
assets, and the euphoria happens to 'monetise' credit in 
new ways that are excluded from the definition, the amount
of money defined in the old way will not grow, but its 
velocity will increase. . .fix any [definition of money]
and the market will create new forms of money in periods
of boom to get round the limit."</i> [<b>Manias, Panics and
Crashes</b>, p. 48]
</blockquote><p>
The experience of the Thatcher and Reagan regimes indicates
this well. The Thatcher government could not meet the
money controls it set -- the growth was 74%, 37% and 23%
above the top of the ranges set in 1980 [Ian Gilmore,
<b>Dancing With Dogma</b>, p. 22]. It took until 1986 before 
the Tory government stopped announcing monetary targets,
persuaded no doubt by its inability to hit them. In addition, 
the variations in the money supply also showed that Milton 
Friedman's argument on what caused inflation was also wrong. 
According to his theory, inflation was caused by the money 
supply increasing faster than the economy, yet inflation
<b>fell</b> as the money supply increased. As the moderate 
conservative Ian Gilmore points out, <i>"[h]ad Friedmanite 
monetarism. . . been right, inflation would have been about 
16 per cent in 1982-3, 11 per cent in 1983-4, and 8 per 
cent in 1984-5. In fact . . . in the relevant years it 
never approached the levels infallibly predicted by 
monetarist doctrine."</i> [<b>Op. Cit.</b>, p. 52] From an anarchist 
perspective, however, the fall in inflation was the result 
of the high unemployment of this period as it weakened 
labour, so allowing profits to be made in production 
rather than in circulation (see <a href="secC7.html#secc71">
section C.7.1</a>). With no 
need for capitalists to maintain their profits via 
price increases, inflation would naturally decrease as
labour's bargaining position was weakened by massive
unemployment. Rather than being a purely monetary phenomena
as Friedman claimed, it is a product of the profit needs
of capital and the state of the class struggle.
<p>
It is also of interest to note that even in Friedman's own
test of his basic contention, the Great Depression of 1929-33,
he got it wrong. Kaldor noted pointed out that <i>"[a]ccording to 
Friedman's own figures, the amount of 'high-powered money'. . .
in the US increased, not decreased, throughout the Great
Contraction: in July 1932, it was more than 10 per cent higher
than in July, 1929. . . The Great Contraction of the money
supply . . . occurred <b>despite</b> this increase in the monetary
base."</i> [<b>Op. Cit.</b>, pp. 11-12] Other economists also investigated
Friedman's claims, with similar result -- <i>"Peter Temin took 
issue with Friedman and Schwartz from a Keynesian point of
view [in the book <b>Did Monetary Forces Cause the Great
Depression?</b>]. He asked whether the decline in spending 
resulted from a decline in the money supply or the other way
round. . . [He found that] the money supply not only did not
decline but actually increased 5 percent between August 1929
and August 1931. . . Temin concluded that there is no evidence
that money caused the depression between the stock market 
crash and. . . September 1931."</i> [Charles P. Kindleburger, 
<b>Op. Cit.</b>, p. 60]
<p>
In other words, causality runs from the real economy to money,
not vice versa, and fluctuations in the money supply results from
fluctuations in the economy. If the money supply is endogenous,
and it is, this would be expected. Attempts to control the money
supply would, of necessity, fail and the only tool available would
take the form of raising interest rates. This would reduce 
inflation, for example, by depressing investment, generating
unemployment, and so (eventually) slowing the growth in wages.
Which is what happened in the 1980s. Trying to "control" the money 
supply actually meant increasing interest rates to extremely
high levels, which helped produce the worse depression since 
the end of the war (a depression which Friedman notably failed 
to predict).
<p>
Given the absolute failure of Monetarism, in both theory and
practice, it is little talked about now. However, in the 1970s
it was the leading economic dogma of the right -- the right 
which usually likes to portray itself as being strong on the
economy. It is useful to indicate that this is not the case.
In addition, we discuss the failure of Monetarism in order to 
highlight the problems with the <i>"free banking"</i> solution to state 
control of money. This school of thought is associated with the 
"Austrian" school of economics and right-wing libertarians in 
general (we also discuss this theory in <a href="secF10.html#secf101">
section F.10.1</a>). It is 
based on totally privatising the banking system and creating a 
system in which banks and other private companies compete on the 
market to get their coins and notes accepted by the general
population. This position is not the same as anarchist mutual
banking as it is seen not as a way of reducing usury 
to zero but rather as a means of ensuring that interest rates
work as they are claimed to do in capitalist theory.
<p>
The "free banking" school argues that under competitive pressures,
banks would maintain a 100% ratio between the credit they provide
and the money they issue with the reserves they actually have (i.e.
market forces would ensure the end of fractional reserve banking).
They argue that under the present system, banks can create more
credit than they have funds/reserves available. This pushes the
rate of interest below its "natural rate" (i.e. the rate which
equates savings with investment). Capitalists, mis-informed by
the artificially low interest rates invest in more capital
intensive equipment and this, eventually, results in a crisis,
a crisis caused by over-investment ("Austrian" economists term
this <i>"malinvestment"</i>). If banks were subject to market forces, 
it is argued, then they would not generate credit money, interest 
rates would reflect the real rate and so over-investment, and 
so crisis, would be a thing of the past.
<p>
This analysis, however, is flawed. We have noted one flaw above,
namely the problem that interest rates do not provide sufficient
or correct information for investment decisions. Thus relative 
over-investment could still occur. Another problem follows
on from our discussion of Monetarism, namely the endogenous 
nature of money and the pressures this puts on banks. The noted 
post-keynesian economist Hyman Minsky created an analysis which
gives an insight into why it is doubtful that even a "free banking"
system would resist the temptation to create credit money (i.e.
loaning more money than available savings). This model is often
called <i>"The Financial Instability Hypothesis."</i>
<p>
Let us assume that the economy is going into the recovery period
after a crash. Initially firms would be conservative in their
investment while banks would lend within their savings limit 
and to low-risk investments. In this way the banks do ensure 
that the interest rate reflects the natural rate. However, this
combination of a growing economy and conservatively financed
investment means that most projects succeed and this gradually
becomes clear to managers/capitalists and bankers. As a result,
both managers and bankers come to regard the present risk 
premium as excessive. New investment projects are evaluated
using less conservative estimates of future cash flows. This
is the foundation of the new boom and its eventual bust. In
Minsky's words, <i>"stability is destabilising."</i>
<p>
As the economy starts to grow, companies increasingly turn to
external finance and these funds are forthcoming because the
banking sector shares the increased optimism of investors.
Let us not forget that banks are private companies too and so
seek profits as well. Providing credit is the key way of doing
this and so banks start to accommodate their customers and
they have to do this by credit expansion. If they did not,
the boom would soon turn into slump as investors would have
no funds available for them and interest rates would increase,
thus forcing firms to pay more in debt repayment, an increase
which many firms may not be able to do or find difficult. This
in turn would suppress investment and so production, generating 
unemployment (as companies cannot "fire" investments as easily 
as they can fire workers), so reducing consumption demand along 
with investment demand, so deepening the slump.
<p>
However, due to the rising economy bankers accommodate their
customers and generate credit rather than rise interest rates.
In this way they accept liability structures both for themselves
and for their customers <i>"that, in a more sober expectational
climate, they would have rejected."</i> [Minsky, <b>Inflation, 
Recession and Economic Policy</b>, p. 123] The banks innovate
their financial products, in other words, in line with demand. 
Firms increase their indebtedness and banks are more than 
willing to allow this due to the few signs of financial strain
in the economy. The individual firms and banks increase their
financial liability, and so the whole economy moves up the
liability structure.
<p>
However, eventually interest rates rise (as the existing extension 
of credit appears too high) and this affects all firms, from the 
most conservative to the most speculative, and "pushes" them up 
even higher up the liability structure (conservative firms no 
longer can repay their debts easily, less conservative firms 
fail to pay them and so on). The margin of error narrows and 
firms and banks become more vulnerable to unexpected developments, 
such a new competitors, strikes, investments which do not generate 
the expected rate of return, credit becoming hard to get, interest
rates increase and so on. In the end, the boom turns to slump 
and firms and banks fail. 
<p>
The "free banking" school reject this claim and argue that 
private banks in competition would <b>not</b> do this as this 
would make them appear less competitive on the market and 
so customers would frequent other banks (this is the same 
process by which inflation would be solved by a "free 
banking" system). However, it is <b>because</b> the banks are 
competing that they innovate -- if they do not, another 
bank or company would in order to get more profits. This 
can be seen from the fact that <i>"[b]ank notes. . . and 
bills of exchange. . . were initially developed because 
of an inelastic supply of coin"</i> [Kindleburger, <b>Op. Cit.</b>, 
p. 51] and <i>"any shortage of commonly-used types [of money] 
is bound to lead to the emergence of new types; indeed, 
this is how, historically, first bank notes and the 
chequing account emerged"</i> [Kaldor, <b>Op. Cit.</b>, p. 10]
<p>
This process can be seen at work in Adam Smith's <b>The Wealth
of Nations</b>. Scotland in Smith's time was based on a competitive
banking system and, as Smith notes, they issued more money than 
was available in the banks coffers:
<p><blockquote>
<i>"Though some of those notes [the banks issued] are continually
coming back for payment, part of them continue to circulate for
months and years together. Though he [the banker] has generally
in circulation, therefore, notes to the extent of a hundred
thousand pounds, twenty thousand pounds in gold and silver
may frequently be a sufficient provision for answering 
occasional demands."</i> [<b>The Wealth of Nations</b>, pp. 257-8]
</blockquote><p>
In other words, the competitive banking system did not, in 
fact, eliminate fractional reserve banking. 
Ironically enough, Smith noted that <i>"the Bank of England paid
very dearly, not only for its own imprudence, but for the much
greater imprudence of almost all of the Scotch [sic!] banks."</i>
[<b>Op. Cit.</b>, p. 269] Thus the central bank was more conservative
in its credit generation than the banks under competitive 
pressures! Indeed, Smith argues
that the banking companies did not, in fact, act in line with
their interests as assumed by the "free banking" school:
<p><blockquote>
<i>"had every particular banking company always understood and
and attended to its own particular interest, the circulation
never could have been overstocked with paper money. But every
particular baking company has not always understood and
attended to its own particular interest, and the circulation
has frequently been overstocked with paper money."</i> [<b>Op. Cit.</b>,
p. 267]
</blockquote><p>
Thus we have reserve banking plus bankers acting in ways
opposed to their <i>"particular interest"</i> (i.e. what economics
consider to be their actual self-interest rather than what
the bankers actually thought was their self-interest!) in a
system of competitive banking. Why could this be the case?
Smith mentions, in passing, a possible reason. He notes that
<i>"the high profits of trade afforded a great temptation to
over-trading"</i> and that while a <i>"multiplication of banking
companies. . . increases the security of the public"</i> by forcing
them <i>"to be more circumspect in their conduct"</i> it also <i>"obliges
all bankers to be more liberal in their dealings with their
customers, lest their rivals should carry them away."</i> [<b>Op.
Cit.</b>, p. 274, p. 294]
<p>
Thus "free banking" is pulled in two directions at once, to
accommodate their customers while being circumspect in their
activities. Which factor prevails would depend on the state
of the economy, with up-swings provoking liberal lending (as
described by Minsky). Moreover, given that the "free banking"
school argues that credit generation produces the business
cycle, it is clear from the case of Scotland that competitive
banking does not, in fact, stop credit generation (and so
the business cycle, according to "Austrian" theory). This 
also seemed the case with 19th century America, which did 
not have a central bank for most of that period -- <i>"the 
up cycles were also extraordinary [like the busts], powered 
by loose credit and kinky currencies (like privately issued 
banknotes)."</i> [Doug Henwood, <b>Wall Street</b>, p. 94]
<p>
Most "free banking" supporters also argue that regulated systems
of free banking were more unstable than unregulated. Perhaps this
is the case, but that implies that the regulated systems could
not freely accommodate their customers by generating credit and 
the resulting inflexible money regime created problems by 
increasing interest rates and
reducing the amount of money available, which would result in a
slump sooner rather than later. Thus the over supply of credit,
rather than being the <b>cause</b> of the crisis is actually a symptom.
Competitive investment also drives the business-cycle expansion, 
which is allowed and encouraged by the competition among banks in 
supplying credit. Such expansion complements -- and thus amplifies 
-- other objective tendencies towards crisis, such as over-investment 
and disportionalities.
<p>
In other words, a pure "free market" capitalist would still have a business
cycle as this cycle is caused by the nature of capitalism, not by state
intervention. In reality (i.e. in "actually existing" capitalism), state 
manipulation of money (via interest rates) is essential for the capitalist 
class as it is more related to indirect profit-generating activity, such as 
ensuring a "natural" level of unemployment to keep profits up, an acceptable 
level of inflation to ensure increased profits, and so forth, as well as
providing a means of tempering the business cycle, organising bailouts
and injecting money into the economy during panics. If state manipulation 
of money caused the problems of capitalism, we would not have seen the 
economic successes of the post-war Keynesian experiment or the business 
cycle in pre-Keynesian days and in countries which had a more free banking 
system (for example, nearly half of the late 19th century in the US was 
spent in periods of recession and depression, compared to a fifth since 
the end of World War II). 
<p>
It is true that all crises have been preceded by a speculatively-enhanced
expansion of production and credit. This does not mean, however, that
crisis <b>results</b> from speculation and the expansion of credit. The 
connection is not causal in free market capitalism. The expansion and 
contraction of credit is a mere symptom of the periodic changes in the 
business cycle, as the decline of profitability contracts credit just 
as an increase enlarges it.
<p>
Paul Mattick gives the correct analysis: 
<p><blockquote>
<i>"[M]oney and credit policies can themselves change nothing with 
regard to profitability or insufficient profits. Profits come only 
from production, from the surplus value produced by workers. . . 
The expansion of credit has always been taken as a sign of a coming 
crisis, in the sense that it reflected the attempt of individual 
capital entities to expand despite sharpening competition, and 
hence survive the crisis. . . Although the expansion of credit has
staved off crisis for a short time, it has never prevented it, since
ultimately it is the real relationship between total profits and the 
needs of social capital to expand in value which is the decisive factor, 
and that cannot be altered by credit."</i> [<b>Economics, Politics and the 
Age of Inflation</b>, pp. 17-18]
</blockquote><p>
In short, the apologists of "free market" capitalism confuse the 
symptoms for the disease. 
<p>
Where there is no profit to be had, credit will not be sought. While
extension of the credit system <i>"can be a factor deferring crisis, the
actual outbreak of crisis makes it into an aggravating factor because 
of the larger amount of capital that must be devalued."</i> [Paul Mattick, 
<b>Economic Crisis and Crisis Theory</b>, p. 138] But this is also a problem 
facing private companies using the gold standard, as advocated by 
right-wing Libertarians (who are supporters of "free market" capitalism
and banking). The money supply reflects the economic activity within 
a country and if that supply cannot adjust, interest rates rise and 
provoke a crisis. Thus the need for a flexible money supply (as 
desired, for example, by the US Individualist Anarchists). As Adam 
Smith pointed out, <i>"the quantity of coin in every country is regulated 
by the value of the commodities which are to be circulated by it: 
increase that value and . . . the additional quantity of coin 
requisite for circulating them [will be found]."</i> [<b>Op. Cit.</b>, p. 385] 
<p>
Token money came into being because commodity money proved to be too 
inflexible for this to occur, as <i>"the expansion of production or 
trade unaccompanied 
by an increase in the amount of money must cause a fall in the price 
level. . . Token money was developed at an early date to shelter 
trade from the enforced deflations that accompanied the use of 
specie when the volume of business swelled. . . Specie is an 
inadequate money just because it is a commodity and its amount 
cannot be increased at will. The amount of gold available may be
increased by a few per cent a year, but not by as many dozen within 
a few weeks, as might be required to carry out a sudden expansion of
transactions. In the absence of token money business would have to 
be either curtailed or carried on at very much lower prices, thus 
inducing a slump and creating unemployment."</i> [Karl Polyani, <b>The 
Great Transformation</b>, p. 193]
<p>
To sum up, <i>"[i]t is not credit but only the increase in production made
possible by it that increases surplus value. It is then the rate of
exploitation which determines credit expansion."</i> [Paul Mattick, 
<b>Economics, Politics and the Age of Inflation</b>, p. 18] Hence token 
money would increase and decrease in line with capitalist profitability, 
as predicted in capitalist economic theory. But this could not affect 
the business cycle, which has its roots in production for capital (i.e.
profit) and capitalist authority relations, to which the credit supply
would obviously be tied, and not vice versa. 
<p>
<a name="secc81"><h2>C.8.1 Does this mean that Keynesianism works?</h2>
<p>
If state control of credit does not cause the business cycle, does that
mean Keynesianism capitalism can work? Keynesian economics, as opposed
to free market capitalism, maintains that the state can and should intervene
in the economy in order to stop economic crises from occurring. The
post-war boom presents compelling evidence that it can be effect the
business cycle for the better by reducing its impact from developing into
a full depression.
<p>
The period of social Keynesianism after the war was marked by reduced
inequality, increased rights for working people, less unemployment, a 
welfare state you could actually use and so on. Compared to present-day 
capitalism, it had much going for it. However, Keynesian capitalism is still 
capitalism and so is still based upon oppression and exploitation. It was, in 
fact, a more refined form of capitalism, within which the state intervention 
was used to protect capitalism from itself while trying to ensure that working
class struggle against it was directed, via productivity deals, into 
keeping the system going. For the population at large, the general idea 
was that the welfare state (especially in Europe) was a way for society 
to get a grip on capitalism by putting some humanity into it. In a confused
way, the welfare state was supported as an attempt to create a society in 
which the economy existed for people, not people for the economy.
<p>
While the state has always had a share in the total surplus value produced 
by the working class, only under Keynesianism is this share increased 
and used actively to manage the economy. Traditionally, placing checks on 
state appropriation of surplus value had been one of the aims of classical 
capitalist thought (simply put, cheap government means more surplus value 
available for capitalists to compete for). But as capital  has accumulated, 
so has the state increased and its share in social surplus (for control over 
the domestic enemy has to be expanded and society protected from the 
destruction caused by free market capitalism).
<p>
Indeed, such state intervention was not <b>totally</b> new for <i>"[f]rom its origins, 
the United States had relied heavily on state intervention and protection for 
the development of industry and agriculture, from the textile industry in the 
early nineteenth century, through the steel industry at the end of the century,
to computers, electronics, and biotechnology today. Furthermore, the same has
been true of every other successful industrial society."</i> [<b>World Orders,
Old and New</b>, p. 101]
<p>
The roots of the new policy of higher levels and different forms of state 
intervention lie in the Great Depression of the 1930s and the realisation 
that attempts to enforce widespread reductions in money wages and costs 
(the traditional means to overcome depression) were impossible because 
the social and economic costs would have been too expensive. A militant 
strike wave involving  a half million workers occurred in 1934, 
with factory occupations and other forms of militant direct action 
commonplace.
<p>
Instead of attempting the usual class war (which may have had revolutionary
results), sections of the capitalist class thought a new approach was
required. This involved using the state to manipulate credit in order to
increase the funds available for capital and to increase demand by state
orders. As Paul Mattick points out:
<p><blockquote>
<i>"The additional production made possible by deficit financing does appear
as additional demand, but as demand unaccompanied by a corresponding increase
in total profits. . . [this] functions immediately as an increase in
demand that stimulates the economy as a whole and can become the point
for a new prosperity"</i> if objective conditions allow it. [<b>Economic
Crisis and Crisis Theory</b>, p. 143]
</blockquote>
<p>
State intervention can, in the short term, postpone crises by stimulating
production. This can be seen from the in 1930s New Deal period under Roosevelt
when the economy grew five years out of seven compared to it shrinking
every year under the pro-laissez-faire Republican President Herbert Hoover
(under Hoover, the GNP shrank an average of -8.4 percent a year, under
Roosevelt it grew by 6.4 percent). The 1938 slump after 3 years of growth
under Roosevelt was due to a decrease in state intervention:
<p><blockquote>
<i>"The forces of recovery operating within the depression, as well as the
decrease in unemployment via public expenditures, increased production up
to the output level of 1929. This was sufficient for the Roosevelt 
administration to drastically reduce public works. . . in a new effort to
balance the budget in response to the demands of the business world. . . The
recovery proved to be short-lived. At the end of 1937 the Business Index
fell from 110 to 85, bring the economy back to the state in which it had
found itself in 1935. . . Millions of workers lost their jobs once again."</i>
[Paul Mattick, <b>Economics, Politics and the Age of Inflation</b>, p. 138]
</blockquote><p>
With the success of state intervention during the second world war, 
Keynesianism was seen as a way of ensuring capitalist survival. The
resulting boom is well known, with state intervention being seen as the
way of ensuring prosperity for all sections of society. Before the Second
World War, the USA (for example) suffered eight depressions, since the war
there has been none (although there has been periods of recession). There
is no denying that for a considerable time, capitalism has been able to 
prevent the rise of depressions which so plagued the pre-war world and 
that this was accomplished by government interventions.
<p>
This is because Keynesianism can serve to initiate a new prosperity and 
postpone crisis by the extension of credit. This can mitigate the conditions
of crisis, since one of its short-term effects is that it offers private
capital a wider range of action and an improved basis for its own efforts
to escape the shortage of profits for accumulation. In addition, Keynesianism 
can fund Research and Development in new technologies and working methods
(such as automation), guarantee markets for goods as well as transferring
wealth from the working class to capital via taxation and inflation.
<p>
In the long run, however, Keynesian <i>"management of the economy by means of 
monetary and credit policies and by means of state-induced production must 
eventually find its end in the contradictions of the accumulation process."</i> 
[Paul Mattick, <b>Op. Cit.</b>, p. 18]
<p>
So, these interventions did not actually set aside the underlying
causes of economic and social crisis. The modifications of the capitalist
system could not totally countermand the subjective and objective limitations
of a system based upon wage slavery and social hierarchy. This can be seen 
when the rosy picture of post-war prosperity changed drastically in the 1970s 
when economic crisis returned with a vengeance, with high unemployment 
occurring along with high inflation. This soon lead to a return to a more 
"free market" capitalism with, in Chomsky's words, <i>"state protection and 
public subsidy for the rich, market discipline for the poor."</i> This process,
and its effects, are discussed in the next two sections.
<p>
<a name="secc82"><h2>C.8.2 What happened to Keynesianism in the 1970s?</h2>
<p>
Basically, the subjective and objective limitations to Keynesianism we
highlighted in the last section were finally reached in the early 1970s. 
Economic crisis returned with massive unemployment accompanied with high 
inflation, with the state interventions that for so long kept capitalism 
healthy making the crisis worse. In other words, a combination of social 
struggle and a lack of surplus value available to capital resulted in the 
breakdown of the successful post-war consensus.
<p>
The roots and legacy of this breakdown in Keynesianism is informative and
worth analysing. The post-war period marked a distinct change for capitalism, 
with new, higher levels of state intervention. So why the change? Simply put, 
because capitalism was not a viable system. It had not recovered from the 
Great Depression and the boom economy during war had obviously contrasted 
deeply with the stagnation of the 1930s. Plus, of course, a militant working 
class, which has put up with years of denial in the struggle against 
fascist-capitalism would not have taken lightly to a return to mass 
unemployment and poverty. So, politically and economically a change was 
required. This change was provided by the ideas of Keynes, a change which
occurred under working class pressure but in the interests of the ruling
class.
<p>
The mix of intervention obviously differed from country to country, based
upon the needs and ideologies of the ruling parties and social elites. In
Europe nationalisation was widespread as inefficient capital was taken
over by the state and reinvigorated by state funding and social spending
more important as Social Democratic parties attempted to introduce reforms.
Chomsky describes the process in the USA:
<p><blockquote>
<i>"Business leaders recognised that social spending could stimulate the
economy, but much preferred the military Keynesian alternative - for
reasons having to do with privilege and power, not 'economic rationality.'
This approach was adopted at once, the Cold War serving as the justification.
. . . The Pentagon system was considered ideal for these purposes. It extends
well beyond the military establishment, incorporating also the Department of
Energy. . . and the space agency NASA, converted by the Kennedy administration
to a significant component of the state-directed public subsidy to advanced
industry. These arrangements impose on the public a large burden of the
costs of industry (research and development, R&D) and provide a guaranteed
market for excess production, a useful cushion for management decisions.
Furthermore, this form of industrial policy does not have the undesirable
side-effects of social spending directed to human needs. Apart from unwelcome
redistributive effects, the latter policies tend to interfere with managerial
prerogatives; useful production may undercut private gain, while 
state-subsidised waste production. . . is a gift to the owner and manager,
to whom any marketable spin-offs will be promptly delivered. Social
spending may also resource public interest and participation, thus enhancing
the threat of democracy. . . The defects of social spending do not taint
the military Keynesian alternative. For such reasons, <b>Business Week</b>
explained, 'there's a tremendous social and economic difference between
welfare pump-priming and military pump-priming,' the latter being far
preferable."</i> [<b>World Orders, Old and New</b>, pp. 100-101]
</blockquote><p>
Over time, social Keynesianism took increasing hold even in the USA, partly
in response to working class struggle, partly due to the need for popular
support at elections and partly due to <i>"[p]opular opposition to the Vietnam 
war [which] prevented Washington from carrying out a national mobilisation. . . 
which might have made it possible to complete the conquest without harm to 
the domestic economy. Washington was forced to fight a 'guns-and-butter' was 
to placate the population, at considerable economic cost."</i> [Noam Chomsky,
<b>Op. Cit.</b>, pp. 157-8]
<p>
Social Keynesianism directs part of the total surplus value to workers
and unemployed while military Keynesianism transfers surplus value from
the general population to capital and from capital to capital. This allows
R&D and capital to be publicly subsidised, as well as essential but 
unproductive capital to survive. As long as real wages did not exceed a 
rise in productivity, Keynesianism would continue. However, both functions 
have objective limits as the transfer of profits from successful capital to 
essential, but less successful, or long term investment can cause a crisis 
is there is not enough profit available to the system as a whole. The 
surplus value producing capital, in this case, would be handicapped due 
to the transfers and cannot respond to economic problems with freely as 
before.
<p>
This lack of profitable capital was part of the reason for the collapse
of the post-war consensus. In their deeply flawed 1966 book, <b>Monopoly 
Capital</b>, radical economists Baran and Sweezy point out that <i>"[i]f 
military 
spending were reduced once again to pre-Second World War proportions the 
nation's economy would return to a state of profound depression"</i> [p. 153] 
<p>
In other words, the US economy was still in a state of depression,
countermanded by state expenditures (for a good, if somewhat economic, 
critique of Baran and Sweezy see Paul Mattick's <i>"Monopoly Capital"</i> in 
<b>Anti-Bolshevik Communism</b>).
<p>
In addition, the world was becoming economically "tripolar," with a revitalised 
Europe and a Japan-based Asian region emerging as major economic forces. This
placed the USA under increased pressure, as did the Vietnam War. However, 
the main reason for its breakdown was social struggle by working people. The
only limit to the rate of growth required by Keynesianism to function is
the degree to which final output consists of consumption goods for the
presently employed population instead of investment. And investment is the
most basic means by which work, i.e. capitalist domination, is imposed. 
Capitalism and the state could no longer ensure that working class struggles
could be contained within the system.
<p>
This pressure on US capitalism had an impact in the world economy and was 
also accompanied by general social struggle across the world. This struggle
was directed against hierarchy in general, with workers, students, women, 
ethnic groups, anti-war protesters and the unemployed all organising successful 
struggles against authority. This struggle attacked the hierarchical core of 
capitalism as well increasing the amount of income going to labour, resulting 
in a profit squeeze (see section <a href="secC7.html">C.7</a>) creating an 
economic crisis. 
<p>
In other words, post-war Keynesianism failed simply because it could not,
in the long term, stop the subjective and objective pressures which capitalism 
always faces.
<p>
<a name="secc83"><h2>C.8.3 How did capitalism adjust to the crisis in Keynesianism?</h2>
<p>
Basically by using, and then managing, the 1970s crisis to discipline the 
working class in order to reap increased profits and secure and extend the
ruling classes' power. It did this using a combination of crisis, free markets 
and adjusted Keynesianism as part of a ruling elite lead class war against 
labour.
<p>
In the face of crisis in the 1970s, Keynesianist redirection of profits 
between capitals and classes had become a burden to capital as a whole 
and had increased the expectations and militancy of working people to 
dangerous levels. The crisis, however, helped control working class power 
and was latter utilised as a means of saving capitalism.
<p>
Initially the crisis was used to justify attacks on working class people 
in the name of the free market. And, indeed, capitalism was made more market 
based, although with a "safety net" and "welfare state" for the wealthy. We 
have seen a partial return to <i>"what economists have called freedom of industry 
and commerce, but which really meant the relieving of industry from the 
harassing and repressive supervision of the State, and the giving to it 
full liberty to exploit the worker, whom was still to be deprived of his 
freedom."</i> [Peter Kropotkin, <b>The Great French Revolution</b>, p. 28] The
"crisis of democracy" was overcome and replaced with the <i>"liberty to exploit 
human labour without any safeguard for the victims of such exploitation and 
the political power organised as to assure freedom of exploitation to the 
middle-class."</i> [<b>Op. Cit.</b>, p. 30]
<p>
Then under the rhetoric of "free market" capitalism, Keynesianism was used 
to manage the crisis as it had previously managed the prosperity. "Supply
Side" economics (combined with neo-classical dogma) was used to undercut
working class power and consumption and so allow capital to reap more
profits off working people. Unemployment was used to discipline a militant
workforce and as a means of getting workers to struggle <b>for</b> work instead
of <b>against</b> wage labour. With the fear of job loss hanging over their heads, 
workers put up with speedups, longer hours, worse conditions, less safety 
protection and lower wages and this increased the profits that could be 
extracted directly from workers as well as reducing business costs by allowing 
employers to reduce on-job safety and protection and so on.  The labour
"market" was fragmented to a large degree into powerless, atomised units with 
unions fighting a losing battle in the face of state backed recession. In 
this way capitalism could successfully change the composition of demand from
the working class to capital.
<p>
This disciplining of the working class resulted in the income going to capital 
increasing by more than double the amount of that going to "labour." Between 
1979 and 1989, total labour income rose by 22.8%, total capital income rose 
by 65.3% and realised capital gains by 205.5%. The real value of a standard
welfare benefit package has also declined by some 26 percent since 1972. 
[Edward S. Herman, <i>"Immiserating Growth: The First World"</i>, <b>Z Magazine</b>] 
And Stanford University economist Victor Fuch estimates that US children
have lost 10-12 hours of parental time between 1960 and 1986, leading to
a deterioration of family relations and values. Unemployment and 
underemployment is still widespread, with most newly created jobs 
being part-time.
<p>
We should point out that the growth in income going to labour includes all 
"labour" incomes and as such includes the "wages" of CEOs and high level 
managers. As we have already noted, these "wages" are part of the surplus 
value extracted from workers and so should not be counted as income to
"labour." The facts of the Reagan fronted class war of the 1980s is that 
while top management income has skyrocketed, workers wages have remained 
usually stable or decreased absolutely. For example, the median hourly wage 
of US production workers has fallen by some 13% since 1973 (we are not 
implying that only production workers create surplus value or are "the 
working class").  In contrast, US management today receives 150 times what the 
average worker earns. Unsurprisingly 70% of the recent gain in per capita 
income have gone to the top 1% of income earners (while the bottom lost 
absolutely). [Chomsky, <b>Op. Cit.</b>, p. 141] Income inequality has increased, 
with the income of the bottom fifth of the US population falling by 18%, 
while that of the richest fifth rose by 8%.
<p>
Indirect means of increasing capital's share in the social income were also 
used, such as reducing environment regulations, so externalising pollution
costs onto current and future generations. In Britain, state owned
monopolies were privatised at knock-down prices allowing private capital 
to increase its resources at a fraction of the real cost. Indeed, some 
nationalised industries were privatised <b>as monopolies</b> allowing monopoly 
profits to be extracted from consumers for many years before the state allowed 
competition in those markets. Indirect taxation also increased, being used 
to reduce working class consumption by getting us to foot the bill for 
Pentagon-style Keynesianism. 
<p>
Exploitation of under-developed nations increased with $418 billion being 
transferred to the developed world between 1982 and 1990 [Chomsky, <b>Op. Cit.</b>, 
p. 130] Capital also became increasingly international in scope, as it used 
advances in technology to move capital to third world countries where state 
repression ensured a less militant working class. This transfer had the 
advantage of increasing unemployment in the developed world, so placing more 
pressures upon working class resistance.
<p>
This policy of capital-led class war, a response to the successful working 
class struggles of the 1960s and 1970s, obviously reaped the benefits it
was intended to for capital. Income going to capital has increased and
that going to labour has declined and the "labour market" has been disciplined
to a large degree (but not totally we must add). Working people have been
turned, to a large degree, from participants into spectators, as required 
for any hierarchical system. The human impact of these policies cannot be 
calculated. Little wonder, then, the utility of neo-classical dogma to the 
elite - it could be used by rich, powerful people to justify the fact that 
they are pursuing social policies that create poverty and force children 
to die. 
<p>
As Chomsky argues, <i>"one aspect of the internationalisation of the economy
is the extension of the two-tiered Third World mode to the core countries.
Market doctrine thus becomes an essential ideological weapon at home as
well, its highly selective application safely obscured by the doctrinal
system. Wealth and power are increasingly concentrated. Service for the 
general public - education, health, transportation, libraries, etc. -
become as superfluous as those they serve, and can therefore be limited
or dispensed with entirely."</i> [<b>Year 501</b>, p. 109]
<p>
The state managed recession has had its successes. Company profits are
up as the <i>"competitive cost"</i> of workers is reduced due to fear of job
losses. The <b>Wall Street Journal</b>'s review of economic performance 
for the last quarter of 1995 is headlined <i>"Companies' Profits Surged 61% 
on Higher Prices, Cost Cuts."</i> After-tax profits rose 62% from 1993, up 
from 34% for the third quarter. While working America faces market forces,
Corporate America posted record profits in 1994. <b>Business Week</b>
estimated 1994 profits to be up <i>"an enormous 41% over [1993],"</i> despite
a bare 9% increase in sales, a <i>"colossal success,"</i> resulting in large 
part from a <i>"sharp"</i> drop in the <i>"share going to labour,"
</i> though <i>"economists say labour will benefit -- eventually."</i> 
[cited by Noam Chomsky, <i>"Rollback III"</i>,<b>Z Magazine</b>, 
April 1995]
<p>
Moreover, for capital, Keynesianism is still goes on as before, combined 
(as usual) with praises to market miracles. For example, Michael Borrus,
co-director of the Berkeley Roundtable on the International Economy (a 
corporate-funded trade and technology research institute), cites a 1988 
Department of Commerce study that states that <i>"five of the top six fastest 
growing U.S. industries from 1972 to 1988 were sponsored or sustained, 
directly or indirectly, by federal investment."</i> He goes on to state
that the <i>"winners [in earlier years were] computers, biotechnology, jet 
engines, and airframes"</i> all <i>"the by-product of public spending."
</i> [cited by Chomsky, <b>World Orders, Old and New</b>, p. 109] 
<p>
As James Midgley points out, <i>"the aggregate size of the public sector did 
not decrease during the 1980s and instead, budgetary policy resulted in a 
significant shift in existing allocations from social to military and law 
enforcement."</i> [<i>"The radical right, politics and society"</i>, 
<b>The Radical Right and the Welfare State</b>, Howard Glennerster and 
James Midgley (eds.), p. 11]
<p>
Indeed, the US state funds one third of all civil R&D projects, and the UK 
state provides a similar subsidy. [Chomsky, <b>Op. Cit.</b>, p. 107] And 
after the widespread collapse of Savings and Loans Associations in deregulated 
corruption and speculation, the 1980s pro-"free market" Republican 
administration happily bailed them out, showing that market forces were 
only for one class.
<p>
The corporate owned media attacks social Keynesianism, while remaining
silent or justifying pro-business state intervention. Combined with
extensive corporate funding of right-wing "think-tanks" which explain why
(the wrong sort of) social programmes are counter-productive, the corporate 
state system tried to fool the population into thinking that there is no
alternative to the rule by the market while the elite enrich themselves
at the publics expense.
<p>
So, social Keynesianism has been replaced by Pentagon Keynesianism cloaked
beneath the rhetoric of "free market" dogma. Combined with a strange
mix of free markets (for the many) and state intervention (for the select
few), the state has become stronger and more centralised and <i>"prisons also 
offer a Keynesian stimulus to the economy, both to the construction business 
and white collar employment; the fastest growing profession is reported to 
be security personnel."</i> [Chomsky, <b>Year 501</b>, p. 110] 
<p>
While working class resistance continues, it is largely defensive, but, as
in the past, this can and will change. Even the darkest night ends with
the dawn and the lights of working class resistance can be seen across
the globe. For example, the anti-Poll Tax struggle in  Britain against the
Thatcher Government was successful as have been many anti-cuts struggles
across the USA and Western Europe, the Zapatista uprising in Mexico is
inspiring and there has been continual strikes and protests across the 
world. Even in the face of state repression and managed economic recession,
working class people are still fighting back. The job for anarchists to is 
encourage these sparks of liberty and help them win.
<p>

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