C.8 Is state control of money the cause of the business cycle?

As explained in the last section, 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 external 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.

It should be noted that many supporters of capitalism ignore the "subjective" pressures on capitalism that we discussed in section C.7.1. In addition, the problems associated with rising capital investment (as highlighted in section C.7.3) 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 section C.7.2.

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 real 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.

Before discussing whether state control of money is 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 not clear that the relevant 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 specific 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, not 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.

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 real savings available). The credit system, therefore, does not communicate the relevant 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).

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 creating 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.

There are two main approaches to the question of eliminating state control of money in "free market" capitalist economics -- Monetarism and what is often called "free banking." 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).

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 "The Role of Monetary Policy" in American Economic Review, 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.

Thus Monetarists argued for controlling the money supply, of placing the state under a "monetary constitution" 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 "monetary constitution" 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.

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).

Firstly, the attempt to control the money supply failed, as predicted in 1970 by the radical Keynesian Nicholas Kaldor (see his essay "The New Monetarism" in Further Essays on Applied Economics, 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 "exogenous" and so determined outside the economy by the state when, in fact, it is "endogenous" in nature (i.e. comes from within the economy). This means that any attempt to control the money supply will fail. Charles P. Kindleburger comments:

"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." [Manias, Panics and Crashes, p. 48]

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, Dancing With Dogma, 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 fell as the money supply increased. As the moderate conservative Ian Gilmore points out, "[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." [Op. Cit., 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 section C.7.1). 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.

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 "[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 despite this increase in the monetary base." [Op. Cit., pp. 11-12] Other economists also investigated Friedman's claims, with similar result -- "Peter Temin took issue with Friedman and Schwartz from a Keynesian point of view [in the book Did Monetary Forces Cause the Great Depression?]. 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." [Charles P. Kindleburger, Op. Cit., p. 60]

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).

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 "free banking" 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 section F.10.1). 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.

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 "malinvestment"). 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.

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 "The Financial Instability Hypothesis."

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, "stability is destabilising."

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.

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 "that, in a more sober expectational climate, they would have rejected." [Minsky, Inflation, Recession and Economic Policy, 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.

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.

The "free banking" school reject this claim and argue that private banks in competition would not 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 because 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 "[b]ank notes. . . and bills of exchange. . . were initially developed because of an inelastic supply of coin" [Kindleburger, Op. Cit., p. 51] and "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" [Kaldor, Op. Cit., p. 10]

This process can be seen at work in Adam Smith's The Wealth of Nations. 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:

"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." [The Wealth of Nations, pp. 257-8]

In other words, the competitive banking system did not, in fact, eliminate fractional reserve banking. Ironically enough, Smith noted that "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." [Op. Cit., 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:

"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." [Op. Cit., p. 267]

Thus we have reserve banking plus bankers acting in ways opposed to their "particular interest" (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 "the high profits of trade afforded a great temptation to over-trading" and that while a "multiplication of banking companies. . . increases the security of the public" by forcing them "to be more circumspect in their conduct" it also "obliges all bankers to be more liberal in their dealings with their customers, lest their rivals should carry them away." [Op. Cit., p. 274, p. 294]

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 -- "the up cycles were also extraordinary [like the busts], powered by loose credit and kinky currencies (like privately issued banknotes)." [Doug Henwood, Wall Street, p. 94]

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 cause 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.

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).

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 results 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.

Paul Mattick gives the correct analysis:

"[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." [Economics, Politics and the Age of Inflation, pp. 17-18]

In short, the apologists of "free market" capitalism confuse the symptoms for the disease.

Where there is no profit to be had, credit will not be sought. While extension of the credit system "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." [Paul Mattick, Economic Crisis and Crisis Theory, 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, "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]." [Op. Cit., p. 385]

Token money came into being because commodity money proved to be too inflexible for this to occur, as "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." [Karl Polyani, The Great Transformation, p. 193]

To sum up, "[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." [Paul Mattick, Economics, Politics and the Age of Inflation, 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.

C.8.1 Does this mean that Keynesianism works?

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.

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.

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).

Indeed, such state intervention was not totally new for "[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." [World Orders, Old and New, p. 101]

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.

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:

"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" if objective conditions allow it. [Economic Crisis and Crisis Theory, p. 143]

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:

"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." [Paul Mattick, Economics, Politics and the Age of Inflation, p. 138]

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.

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.

In the long run, however, Keynesian "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." [Paul Mattick, Op. Cit., p. 18]

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, "state protection and public subsidy for the rich, market discipline for the poor." This process, and its effects, are discussed in the next two sections.

C.8.2 What happened to Keynesianism in the 1970s?

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.

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.

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:

"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, Business Week explained, 'there's a tremendous social and economic difference between welfare pump-priming and military pump-priming,' the latter being far preferable." [World Orders, Old and New, pp. 100-101]

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 "[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." [Noam Chomsky, Op. Cit., pp. 157-8]

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.

This lack of profitable capital was part of the reason for the collapse of the post-war consensus. In their deeply flawed 1966 book, Monopoly Capital, radical economists Baran and Sweezy point out that "[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" [p. 153]

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 "Monopoly Capital" in Anti-Bolshevik Communism).

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.

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 C.7) creating an economic crisis.

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.

C.8.3 How did capitalism adjust to the crisis in Keynesianism?

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.

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.

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 "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." [Peter Kropotkin, The Great French Revolution, p. 28] The "crisis of democracy" was overcome and replaced with the "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." [Op. Cit., p. 30]

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 for work instead of against 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.

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, "Immiserating Growth: The First World", Z Magazine] 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.

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, Op. Cit., 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%.

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 as monopolies 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.

Exploitation of under-developed nations increased with $418 billion being transferred to the developed world between 1982 and 1990 [Chomsky, Op. Cit., 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.

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.

As Chomsky argues, "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." [Year 501, p. 109]

The state managed recession has had its successes. Company profits are up as the "competitive cost" of workers is reduced due to fear of job losses. The Wall Street Journal's review of economic performance for the last quarter of 1995 is headlined "Companies' Profits Surged 61% on Higher Prices, Cost Cuts." 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. Business Week estimated 1994 profits to be up "an enormous 41% over [1993]," despite a bare 9% increase in sales, a "colossal success," resulting in large part from a "sharp" drop in the "share going to labour," though "economists say labour will benefit -- eventually." [cited by Noam Chomsky, "Rollback III",Z Magazine, April 1995]

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 "five of the top six fastest growing U.S. industries from 1972 to 1988 were sponsored or sustained, directly or indirectly, by federal investment." He goes on to state that the "winners [in earlier years were] computers, biotechnology, jet engines, and airframes" all "the by-product of public spending." [cited by Chomsky, World Orders, Old and New, p. 109]

As James Midgley points out, "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." ["The radical right, politics and society", The Radical Right and the Welfare State, Howard Glennerster and James Midgley (eds.), p. 11]

Indeed, the US state funds one third of all civil R&D projects, and the UK state provides a similar subsidy. [Chomsky, Op. Cit., 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.

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.

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 "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." [Chomsky, Year 501, p. 110]

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.