Session 12 The Great Roller -Coaster Stability and

Session 12 The Great Roller -Coaster: Stability and Instability in Capitalism Readings: Chapters 23 -24 Illustrations © by Tony Biddle

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Key Topics Covered • Closing the “big circle” of capitalism • Injections and leakages; surpluses and deficits • The multiplier effect • Capitalism’s endless roller-coaster • Recessions and how to stop them • Long waves in the history of capitalism

Key Terms Introduced • • • income expenditure surplus deficit injection leakage multiplier effect recession depression • • • recovery consumer sentiment supply shocks capital flight counter-cyclical policies discretionary fiscal policy automatic stabilizers balanced budget laws long waves

Understanding Capitalism as a System • Two core features define capitalism: – production for profit, and wage labour • Central driving force: investment spending by private businesses – Initiates circle of work, production, income, consumption, reproduction, profit – If it works, capitalist starts it all again • This takes place within a broader context: – Natural environment – Government Financial sector Global linkages

A Complete Economic Road-Map Like any map, it has 3 purposes: 1. Find out where you are 2. Find out where you want to be 3. Find out how to get there

The core cycle of business investment, work, production, income, consumption, reproduction, and profit remains at the centre of the system.

Production and consumption occur in the setting of the natural environment: ecology, raw materials, Pollution.

The financial sector provides credit to facilitate business investment, and then claims a share of the resulting profit. Finance may be sidetracked by speculation.

Government collects taxes from both classes, redistributing some as transfer payments. It also undertakes direct (non-profit) production of public goods and services.

Global linkages include foreign trade (X&M), foreign direct investment (FDI), global financial flows, and migration.

The map is complete!

Review: The Key Players • Worker Households: 85% of population, must sell labour to support themselves. • Capitalists: <5% of population; major owners & top managers, initiate and organize production. • Environment: source of ecological benefits & raw materials. • Banks: special companies which create credit to facilitate investment. • Government: collects taxes, redistributes income, produces public services, regulates production. • Rest of World: linked to our economy through real trade, foreign direct investment, financial flows, migration, and knowledge (technology, ideology).

Review: Key Flows & Functions • Investment: accumulation of tools by capitalist, starts circular flow of production & income. • Production: requires work and tools. • Wages: compensation for wage labour. • Profit: residual surplus kept by capitalist after all the bills are paid. • Workers’ Consumption: financed from wages, allows for reproduction of workers. • Capitalists’ Consumption: purchases of luxury goods, paid from share of profits • Ecological Benefits: space, air, water. • Raw Materials: harvested from nature, then processed. • Pollution: waste flows back to nature.

Key Flows & Functions (cont’d) • Debt (Credit): created by banks to facilitate investment. • Interest: banks’ share of capitalists’ surplus. • Taxes: collected by government from income. • Transfer Payments: redistribution of some tax revenue back to households. • Government Production: direct (non-profit) provision of goods and services. • Exports, Imports: goods and services produced in one country, purchased in another. • Foreign Direct Investment: business locates real capital & initiating production in another country. • Global Financial Flows: international transfers of credit and other financial assets. • Migration: workers crossing borders in search of work.

Key Balances • • For this circular process to continue, there must be enough demand to buy everything produced This can be understood by considering three key balances which must be maintained: 1. Income = expenditure 2. Injections = leakages 3. Sector deficits must offset each other (and hence someone must be increasing debt)

Note to Instructors • The next 6 slides are more technical than most, and can be omitted if desired with no loss in continuity.

Balance #1: Income and Expenditure • The capitalist still must sell all their output for the cycle to keep repeating. • But now they have more options/markets: – Worker consumption – Investment goods – Exports Luxury consumption Government • Total incomes must still be spent to ensure that all output is bought, and prevent a recession.

Income = Expenditure (p. 285) Class / Sector Income Expenditure Workers Wages (W) less Tax (TW) Profit (Π) less Tax (T ) Taxes (TW+ T ) Consumption (CW) Luxury Consumption (C ) Capitalists Government Rest of World TOTAL ECONOMY Government Production (G) Net Exports (X-M) W+Π C + I + G + (X-M) Taxes shown are net of transfers (TP); capitalist sector includes banks.

Balance #2: Injections and Leakages • Injection: initial expenditure “starts the ball rolling. ” – Business investment is the most important in capitalism – But there are others: government production, export demand • Income resulting from the injection (and resulting production) pays for consumption in a circular, “multiplied” process – Consumption depends on income, and hence needs the injection • The money keeps traveling around the circuit until an equivalent amount has “leaked” out (leakages), via: – Capitalist savings (to pay for investment) – Taxes (to pay for government production) – Imports (to pay for production offshore)

Injections = Leakages (p. 288) Spending Injection Unspent Leakage Investment (I) Capitalist saving (Π- C ) Gov’t Production (G) Taxes (TW+ T ) Exports (X) Imports (M) Total Injections: I+G+X Total Leakages: (Π- C ) + T + M The “MULTIPLIER EFFECT”: How much TOTAL income (including stimulated consumption) is generated from an initial injection. The weaker the leakages, the stronger the multiplier.

Balance #3: Offsetting Deficits • In the economy as a whole, income equals expenditure • But for individual sectors, this may not be true – Borrowing can finance spending beyond their income • Across the economy as a whole, these sector deficits will balance each other • Implication: All sectors in the economy cannot reduce their deficits at the same time – That would cause a terrible recession – Some sector(s) must be taking on new debt to create enough demand to purchase all output

Offsetting Deficits (p. 286) Class / Sector Deficit Workers Spend more than their wages Capitalists Government Invest (and consume) more than their profits Spends more than its taxes International Imports more than it exports Total Economy Sum of All Deficits = 0

Understanding the Road Map • • We kept it simple, but ended up with a complex, comprehensive picture of modern capitalism The central “engine” of the economy is profit-seeking business investment Other features round out the picture – environment, finance, government, world – but in many ways still fragile End result: a capitalist system that is diverse, complex, flexible

Capitalism’s Never-Ending Roller Coaster

Defining the Terms: When’s a Downturn a Recession? • “Official” definitions: – Recession: two consecutive quarters of shrinking real GDP – Depression: a very long, deep recession – Recovery: when real GDP stops shrinking and starts growing These definitions are very arbitrary: Unemployment and poverty can grow even if GDP is still growing. And merely having GDP rebound after a recession is no guarantee that people will get better off.

How a Recession Starts • An initial downturn occurs, in some sector of the economy – – • Reduces spending, production, employment in that sector or region Usually, that initial decline alone isn’t enough to cause a recession in the whole economy The chain-reaction from that initial decline is what tips the whole economy into recession – – Attitudes and spending decline in other parts of the economy The recession spreads and grows

How a Recession Spreads Less Investment Less Production & Employment Less Consumption Less Wages

Why Capitalism is Vulnerable to Recessions • • All economies can experience decreases in output But capitalism is uniquely vulnerable to repeating, cyclical patters, for reasons inherent in the system: 1. Profit-seeking business investment is required to put the economy in motion 2. Workers need a job to pay for consumption; consumption spending thus depends on income 3. Each investment reflects each company’s judgment; there’s no planning or coordination

Specific Causes of Economic Cylces • • What caused that initial decline that started the chain-reaction of recession? It can start for many reasons: 1. 2. 3. 4. 5. 6. 7. 8. Investment instability Consumer sentiment (rare) Supply shocks that affect many sectors Monetary policy Banking cycles Financial instability / meltdowns Globalization (trade deficit, investment flight) Government spending cuts

Great Recessions of the Past • • Dirty Thirties: 10 years of depression, due to stock market meltdown and bad government policy. Volcker Shock: Advent of neoliberalism with high interest rates in late 1970 s sparked a worldwide recession. Japan’s Lost Decade: Meltdown of real estate bubble was followed by a decade of stagnation and deflation. Global Financial Crisis: financial meltdown of 2008 -2009 sparked first decline in global GDP since end of World War II. How long will this recession last?

How a Recession Ends • • Sooner or later, optimism returns and some sector of the economy starts growing again Then the chain-reaction that caused the recession to spread, reverses direction: – • • Initial spending stimulates more production, more wages, more consumption, and still more spending Eventually the recovery becomes broad Government policy can accelerate the recovery

Government Counter-Cyclical Policy • – – • • • Deliberate government action can offset the ups and downs of the market Fiscal policy: increase spending or cut taxes in a downturn to stimulate spending, jobs Monetary policy: cut interest rates and allow for easier credit to stimulate spending Discretionary policies require pro-active government decisions Automatic stabilizers help to smooth out cycles automatically On the other hand, government can make things worse if it cuts its own spending during a recession (eg. balanced budget laws)

Capitalism and Long Waves • • – – – In addition to shorter-run cycles in the economy (2 -3 years), there is evidence that capitalism demonstrates longer-run waves (lasting a decade or more). These reflect more lasting swings in technology, economics, and even politics. Recent long waves include: Great Depression: 1930 s Postwar “Golden Age”: vibrant expansion Neoliberalism: initial contractionary effect, more vibrant in 1990 s What comes next? ? ? (after the GFC)

Session #12, Student Exercise: Capitalism’s Fear Factor • Think about all the different ways in which you and your family experience economic risk and insecurity under capitalism. • Fill out a table summarizing your family’s experience with unemployment and dislocation. • Fill out another table listing the different ways instability of the economic system affect workers and their families. • See www. economicsforeveryone. com for copies of the full exercise set and instructions. www. economicsforeveryone. com © Canadian Centre for Policy Alternatives, 2009