New boom or new bubble?
New Left Review 25 Jan Feb 2004
In early 2002 Alan Greenspan declared that the American recession which had begun a year earlier was at an end. By the fall the Fed was obliged to backtrack, admitting that the economy was still in difficulties and deflation a threat. In June 2003 Greenspan was still conceding that ?the economy has yet to exhibit sustainable growth?. Since then Wall Street economists have been proclaiming, with ever fewer qualifications, that after various interruptions attributable to ?external shocks??9/11, corporate scandals and the attack on Iraq?the economy is finally accelerating. Pointing to the reality of faster growth of gdp in the second half of 2003, and a significant increase in profits, they assure us that a new boom has arrived. The question that therefore imposes itself, with a Presidential election less than a year away, is the real condition of the us economy.1 What triggered the slowdown that took place? What is driving the current economic acceleration, and is it sustainable? Has the economy finally broken beyond the long downturn, which has brought ever worse global performance decade by decade since 1973? What is the outlook going forward?
In mid-summer 2000, the us stock market began a sharp descent and the underlying economy rapidly lost steam, falling into recession by early 2001.2 Every previous cyclical downturn of the post-war period had been detonated by a tightening of credit on the part of the Federal Reserve, to contain inflation and economic overheating by reducing consumer demand and, in turn, expenditure on investment. But in this case, uniquely, the Fed dramatically eased credit, yet two closely interrelated forces drove the economy downward. The first of these was worsening over-capacity, mainly in manufacturing, which depressed prices and capacity utilization, leading to falling profitability?which in turn reduced employment, cut investment and repressed wage increases. The second was a collapse of equity prices, especially in high technology lines, which sent the ?wealth effect? into reverse, making it harder for corporations to raise money by issuing shares or incurring bank debt, and for households to borrow against stock.
i. The end of the boom
The recession brought an end to the decade-long expansion that began in 1991 and, in particular, the five-year economic acceleration that began in 1995. That boom was, and continues to be, much hyped, especially as the scene of an ostensible productivity growth miracle.3 In fact, it brought no break from the long downturn that has plagued the world economy since 1973. Above all, in the us, as well as Japan and Germany, the rates of profit in the private economy as a whole failed to revive. The rates for the 1990s business cycle failed to surpass those of the 1970s and 1980s, which were of course well below those of the long post-war boom between the end of the 1940s and end of the 1960s. As a consequence, the economic performance during the 1990s of the advanced capitalist economies taken together (g7), in terms of the standard macro economic indicators, was no better than that of the 1980s, which was in turn less good than that of the 1970s, which itself could not compare to the booming 1950s and 1960s.4
What continued to repress private-sector profitability and prevent any durable economic boom was the perpetuation of a long-term international?that is, systemic?problem of over-capacity in the manufacturing sector. This found expression in the deep dip of?already much reduced?manufacturing profitability in both Germany and Japan during the 1990s, and in the inability of us manufacturers to sustain the impressive recovery in their rates of profit between 1985 and 1995 much past mid-decade. It was manifested too in the series of increasingly deep and pervasive crises that struck the world economy in the last decade of the century?Europe?s erm collapse in 1993, the Mexican shocks of 1994?95, the East Asian emergency of 1997?98, and the crash and recession of 2000?01.
The roots of the slowdown, and more generally the configuration of the us economy today, go back to the mid-1990s, when the main forces shaping the economy of both the boom of 1995?2000 and the slowdown of 2000?03 were unleashed. During the previous decade, helped out by huge revaluations of the yen and the mark imposed by the us government on its Japanese and German rivals at the time of the 1985 Plaza Accord, us manufacturing profitability had made a significant recovery, after a long period in the doldrums, increasing by a full 70 per cent between 1985 and 1995. With the rate of profit outside of manufacturing actually falling slightly in this period, this rise in the manufacturing profit rate brought about, on its own, a quite major increase in profitability for the us private economy as a whole, lifting the non-financial corporate profit rate by 20 per cent over the course of the decade, and regaining its level of 1973. On the basis of this revival, the us economy began to accelerate from about 1993, exhibiting?at least on the surface?greater dynamism than it had in many years.
Nevertheless, the prospects for the American economy were ultimately limited by the condition of the world economy as a whole. The recovery of us profitability was based not only on dollar devaluation, but a decade of close to zero real wage growth, serious industrial shake-out, declining real interest rates, and a turn to balanced budgets. It therefore came very much at the expense of its major rivals, who were hard hit both by the slowed growth of the us market and the improved price competitiveness of us firms in the global economy. It led, during the first half of the 1990s, to the deepest recessions of the post-war epoch in both Japan and Germany, rooted in manufacturing crises in both countries. In 1995, as the Japanese manufacturing sector threatened to freeze up when the exchange rate of the yen rose to 79 to the dollar, the us was obliged to return the favour bestowed upon it a decade earlier by Japan and Germany, agreeing to trigger, in coordination with its partners, a new rise of the dollar. It cannot be overstressed that, with the precipitous ascent of the dollar which ensued between 1995 and 2001, the us economy was deprived of the main motor that had been responsible for its impressive turnaround during the previous decade?viz. the sharp improvement in its manufacturing profitability, international competitiveness and export performance. This in turn set the stage for the dual trends that would shape the American economy throughout the rest of the decade and right up to this day. The first of these was the deepening crisis of the us manufacturing sector, of exports, and (after 2000) of investment; the second was the uninterrupted growth of private-sector debt, household consumption, imports and asset prices, which would make for the sustained expansion of a significant portion of the non-manufacturing sector?above all finance, but also such debt-, import- and consumptiondependent industries as construction, retail trade and health services.
As the dollar skyrocketed after 1995, the burden of international overcapacity shifted to the us. Matters were made much worse for us manufacturers when the East Asian economies entered into crisis in 1997?98, leading to the drying up of East Asian demand, the devaluation of East Asian currencies, and East Asian distress-selling on the world market. From 1997, the us manufacturing profit rate entered a major new decline. Yet, even as manufacturing profitability fell, the us stock market took off. It was initially driven upward by a precipitous decline of long-term interest rates in 1995, which resulted from a huge influx of money from East Asian governments into us financial markets, pushing up the dollar. It was systematically sustained to the end of the decade by the loose-money regime of Alan Greenspan at the Fed, who refused to raise interest rates between early 1995 and mid-1999 and came vigorously to the aid of the equity markets with injections of credit at every sign of financial instability. Greenspan was acutely conscious of the depressive impact on the economy of both Clinton?s moves to balance the budget and the new take-off of the dollar. He therefore looked to the wealth effect of the stock market to offset these by jacking up corporate and household borrowing, and thereby investment and consumer demand. In effect, the Federal Reserve replaced the increase in the public deficit that was so indispensable to us economic growth during the 1980s, with an increase in the private deficit during the second half of the 1990s?a kind of ?stock-market Keynesianism?.5
Once equity prices took off, corporations?especially in information technology?found themselves with unprecedentedly easy access to finance, either through borrowing against the collateral ostensibly represented by their stock-market capitalization or the issuance of shares. As a consequence, the borrowing of non-financial corporations skyrocketed, approaching record levels by the end of the decade. Whereas throughout the post-war epoch, corporations had financed themselves almost entirely out of retained earnings (profits after interest and dividends), now firms that could not borrow cheaply turned to the equity market for funds to an extent that had previously been inconceivable. On these foundations, investment exploded upwards, increasing at an average annual rate of about 10 per cent and explaining, in growth accounting terms, about 30 per cent of the increase in gdp between 1995 and 2000.
Rich households also benefited from the wealth effect of runaway equity prices. As they saw their paper assets soar, they felt justified in raising their annual borrowing, as well as their outstanding debt, to near record levels as a fraction of household income. They also felt free to raise their household consumption as a proportion of personal income to near 100 per cent, bringing about a parallel reduction in the us household savings rate from 8 per cent to near zero over the course of the decade.6 Consumer expenditures jumped sharply, helping mightily to soak up the increased output generated by rising investment and productivity. Between 1995 and 2000, a powerful boom took shape, marked by an acceleration of output, productivity, employment and, eventually, real wage growth. But this boom was almost entirely dependent upon a stock market run-up that had no basis in underlying returns to corporations.
Occurring as it did in the face of the downward trend in profitability?and made possible by increases in corporate borrowing and household consumption that were both dependent upon the stock market bubble?much of the growth in investment of the second half of the decade was inevitably misallocated. The scope and depth of over-capacity was thus very much extended, especially into high-technology industries both within and outside of the manufacturing sector, exacerbating the decline in profitability. Across the economy, the reductions in the growth of costs that resulted from increased productivity were more than offset by the deceleration of price increases that stemmed from the outrunning of demand by supply. Consumers thus ended up as the primary?if only temporary?beneficiaries of a self-undermining process that brought inexorably increasing downward pressure on profits. Between 1997 and 2000, as both the boom and the bubble reached their apogee, the non-financial corporate sector as a whole sustained a fall in profit rate of almost one-fifth.
ii. Crisis of manufacturing and high-tech
But neither the ascent of the real economy, nor that of its on-paper represent ation in the form of asset prices, could long defy the gravitational pull of falling returns. From July 2000, a series of ever-worsening corporate earning reports precipitated a sharp cyclical downturn, both by reversing the wealth effect and by revealing the mass of redundant productive capacity and mountain of corporate indebtedness that constituted the dual legacy of the bubble-driven investment boom. With their market capitalization sharply reduced, firms not only found it more difficult to borrow, but less attractive to do so, especially since declining profits and the growing threat of bankruptcy led them to try to repair balance sheets overburdened by debt. Having purchased far more plant, equipment and software than they could profitably set in motion, they were obliged either to reduce prices or leave capacity unused, sustaining falling profit rates either way. To cope with declining profitability, firms cut back on output and capital expenditures, while reducing employment and wage growth so as to bring down costs. Across the economy these moves radically reduced aggregate demand, pushing the economy downward, while exacerbating profitability decline by depressing capacity utilization and productivity growth. The relentless burden of interest payments on the huge overhang of corporate debt compressed profits even further. Between the year ending in mid-2000 and the year ending in mid-2001, gdp growth fell from 5 per cent to minus 1 per cent per annum and investment from 9 per cent to minus 5 per cent?in both cases faster than at any other time since World War ii?sending the economy into a tail-spin.
In 2001, 2002 and the first half of 2003, employment in the non-farm economy (measured in hours and including the self-employed) fell by 2 per cent, 2.5 per cent and 1.5 per cent respectively, after having increased at an average annual rate of more than 2 per cent between 1995 and 2000. This in itself entailed an enormous hit to aggregate demand, an inexorable and persistent downward pull on the economy. Simultaneously real hourly wages, which had grown 3.5 per cent in 2000, were brutally cut back?to minus 0.1 percent, 1.2 per cent and 0.3 per cent, respectively, in 2001, 2002 and the first half of 2003. As a result of the combination of reduced hourly wage growth and falling employment, total real nonfarm compensation?the main element of aggregate demand?fell by 1.2 per cent, 1.4 per cent and 0.2 per cent, respectively, in 2001, 2002 and the first half of 2003, after increasing at an average annual pace of 4.3 per cent between 1995 and 2000. Perhaps most striking of all, after having grown at an average annual rate of 10 per cent between 1995 and 2000, real expenditures on plant and equipment fell sharply in 2001 and 2002, and were flat in the first half of 2003. All else being equal, these huge blows to consumer and investment demand, resulting from the mammoth reductions in employment, compensation and capital spending growth, would have kept the economy in or near recession right into the present. As it was, even in the face of the government?s enormous stimulus programme, they were responsible for driving average annual growth of non-farm gdp from 4.6 per cent between 1995 and 2000 to minus 0.1 per cent in 2001, and preventing it from going higher than 2.7 per cent in 2002 and 2.6 per cent in the first half of 2003.
Exacerbating the downturn, us overseas sales also plummeted. Over the previous two decades the growth of us exports had tended to depend, paradoxically, on the increase of us imports. This is because they relied upon a world economy whose increasingly export-dependent growth had itself become ever more reliant upon the growth of us imports. The stock market?s last upward thrust in the final couple of years of the century had rescued the world economy, as well as us exports, from the East Asian crisis by setting off a short-lived import boom, especially in information technology components. But with us equity prices and investment collapsing?especially, again, in ?new economy? sectors?the process was reversed. Japan, Europe and East Asia now lost steam as fast as the us, while much of the developing world, notably Latin America, was plunged, after a brief honeymoon, back into crisis. Because the economies of the us?s trading partners had become so dependent on sales to the us?and because the us possesses a far greater propensity to import than does either the eu or Japan?the descent into recession reduced the capacity of the rest of the world to absorb us imports more than vice versa. In 2001, 2002 and the first half of 2003, us export growth therefore fell even further behind us import growth than previously. us real imports, after having increased by 13.2 per cent in 2000, dropped by 2.9 per cent in 2001, then grew by 3.7 per cent and 2.25 per cent respectively, in 2002 and the first half of 2003. us real exports, on the other hand, after growing by 9.7 per cent in 2000, fell by 5.4 per cent, 3.6 per cent and 0.1 per cent in 2001, 2002 and the first half of 2003. As the rest of the world, deprived of the American motor, slowed down, the us could look only to itself to launch an economic recovery upon which the whole global economy depended.
To stem the plunge, from January 2001 onwards the Federal Reserve lowered the cost of borrowing with unprecedented rapidity, reducing short-term interest rates on eleven occasions, from 6.5 per cent to 1.75 per cent, over the course of the year. But, as the Fed discovered, interest-rate reductions are much more effective in reviving an economy in which consumption has been restricted by a tightening of credit?as in all previous post-war cyclical downturns?than in re-starting an economy driven into recession by declining investment and employment resulting from over-capacity, making for falling rates of profit.
Vastly over-supplied with plant and equipment, non-financial corporations had little incentive to step up capital accumulation, no matter how far interest rates were brought down by the Fed. On the contrary, having increased their indebtedness from 73 to 90 per cent of their output between 1995 and 2000, they had every motivation to restore their balance sheets by trying to save more, and their doing so made it that much more difficult for them to invest. Whereas vastly increased apparent wealth derived from market capitalization allowed non-financial corporations to raise their borrowing as a proportion of their income to a near record 8 per cent for 1998, 1999 and 2000 taken together, they were obliged sharply to reduce it to 4.6 per cent, 2.1 per cent and 2.6 per cent, in 2001, 2002 and the first half of 2003, as the value of their stock dramatically contracted. Real non-residential expenditures on plant and equipment thus fell like a stone, declining from an average annual rate of 10.1 per cent between 1995 and 2000 to an average annual rate of minus 4.4 per cent between 2000 and the middle of 2003. It has been the failure of investment to revive that has constituted the ultimate factor holding back the economy.
The manufacturing sector was the main, almost exclusive, site and source of the economic slowdown, as developments maturing over the previous half-decade came to fruition. Although by the middle 1990s this sector had come to constitute only 29.3 per cent and 32.7 per cent, respectively, of corporate and non-financial gdp, as late as 1995 manufacturing still accounted for 42.5 per cent of corporate and 50 per cent of non-financial corporate profits before payment of interest. As a consequence, manufacturing?s descent into crisis meant crisis for the whole economy.
Between 1995 and 2000, the growth of costs in the us manufacturing economy posed no threat to profitability. On the contrary: productivity growth in manufacturing grew so rapidly that it more than cancelled out the rise of wages, with the result that unit labour costs fell at an impressive average annual rate of more than 1 per cent a year over the quinquennium. Even so, us producers found it vastly more difficult to defend, let alone expand, their markets and profit margins during this period, because they had to face an appreciation of the dollar in tradeweighted terms of 21 per cent and, from 1997, crisis conditions on the world market. World export prices, measured in dollars, fell at the stunning rate of 4 per cent per annum over the half decade, with the consequence that, while us manufacturing exports increased at an average annual rate of 7 per cent a year, manufacturing imports rose 40 per cent faster, at 10 per cent per annum, and their share of the us market jumped by a third. Despite falling production costs, price pressure was therefore so intense that the manufacturing sector maintained its rates of profit only between 1995 and 1997, and then simply because wage pressure was so weak in those two years, real wages falling by 1.5 per cent. Between 1997 and 2000, prices fell even more than did unit labour costs, with the result that, in that short period, as the economy bubbled over, the manufacturing rate of profit fell by 15 per cent.
In 2001 the crisis in manufacturing reached a climax, as competitive pressures from the world market intensified and were vastly complicated by the slowdown of the domestic market. As world manufacturing prices dropped by a further 2.4 per cent and us manufacturing exports (nominal) fell by 7 per cent, American manufacturers saw growth in real domestic consumption cut by half. In the face of these contractions, us manufacturing gdp dropped by a staggering 6 per cent and capacity utilization declined by 7.1 per cent. Meanwhile, real manufacturing investment fell by 5.4 per cent. With output and capacity utilization, as well as expenditures on new plant, equipment and software, falling off so rapidly, there was no way employers could reduce the labour force fast enough to prevent a huge fall in productivity growth. Employment (measured in hours) was in fact cut back by 4.8 per cent. But the growth of output per hour in manufacturing still plunged from 6.1 per cent in 2000 to minus 0.4 per cent in 2001.
Manufacturing firms responded to these excruciating pressures by battening down employees? compensation: real wages, which had grown by 3.9 per cent in 2000, fell by 1.2 per cent in 2001. But with productivity as well as capacity utilization diving, employers still could not prevent unit labour costs from rising by 2 per cent. Nor could they stop domestic manufacturing prices from falling by 0.4 per cent, after a 2 per cent drop in 2000. The outcome was that in 2001 the rate of profit for the manufacturing sector fell a further 21.3 per cent, to a level over a third down from its 1997 peak. Between 1997 and 2001, as corporate indebtedness rocketed, manufacturing net interest as a proportion of manufacturing net profits rose from 19 per cent to 40.5 per cent, a post-war record. Partly as a consequence, by 2001 manufacturing profits net of interest had fallen a total of 44.4 per cent from their high point in 1997.
The profitability crisis struck all across manufacturing, including traditional industries from textiles to steel to leather. But the eye of the storm was the information technology sector, which is located for the most part in durable goods manufacturing, but includes a few industries outside manufacturing, most notably telecommunications.