The Structural Problem of Depression
In 1934, shortly after Keynes’s breezy and confident letter to President Roosevelt which demanded the United States (a) control the dollar exchange, (b) massively borrow and print money for large capital expenditures to wipe out unemployment, and (c) reduce the interest rate and do everything to engineer cheap and abundant credit, former Austrian finance minister, Joseph Schumpeter, working alone as usual, quietly published a short essay titled Depressions: Can We Learn From Past Experience?. It is not among Schumpeter’s most well-known writings, but is a useful example of what I call *structural* knowledge of crisis, as distinct from so-called ‘market monetarist’ and Keynesian ‘fiscalist’ approaches.
The Year Ahead 2018
The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.
Schumpeter’s essay draws on British and US economic history. There is one exceptional section where he describes two sets of causes and consequences of depression, and some policy problems. The explanation seems highly relevant to the advanced economies in 2013, as I will show with a few contemporary examples.
1. Internal Factors
First, a depression is always traceable to business adaptations to the preceding prosperity. There is innovation, upheaval, “intrusion of new and more efficient methods of production”, and “dislocation of everyone’s profit and loss account”. New methods (computerisation), new infrastructures (telecommunications and the internet), new or more efficient sources and uses of energy; these things eliminate some of the old businesses, and change the ways of doing business. Structural adaptation underlies “the recurrent troubles of capitalist society”, but they are only “temporary” adjustment problems. The dislocations (great losses, bankruptcies, unemployment) are, each time, “the means to reconstruct” economies and make them “efficient” again; they pave the way for “new achievement of the kind which has created modern civilisation”.
In 2013, as in 1933, we must understand that structural dislocation “would happen even if nobody ever made any mistakes and if there were no crooks”. For as long as profits are coming in, most of the bad stuff going on in business conveniently escapes notice. “Errors and misbehaviour”, such as we saw occurred in the banking sector, are likely to “show up” after a period of prosperity “when prices break and credit ceases to expand in response to decreased demand for it”.
Remember that safe and prosperous Credit ‘n’ Gadget feeling in, for example, 2003? It repeats in history:
“When everybody talks of new eras -- blissfully unaware of the fact that soon he will be talking of the hopeless failure of capitalism -- an increasing volume of business is being done on the assumption that things will continue to boom. A superstructure of such transactions rises above what is substantially sound and comes down with a crash as soon as, under the impact of the new products or increased quantities of products, readjustment sets in.”
2. External Factors
Schumpeter then adds that, as well as the processes which are internal to the economic mechanism, there are external (social, political, international) factors acting upon it, and these external factors experience their own “disturbances”. In other words, “we must always bear in mind that what we are faced with is never simply a depression but always a depression moulded and made worse by forces not inherent to the working of the economic engine as such”. During the preceding prosperity and “while margins are wide” these influences are hidden, “but they show as soon as things cease to boom”.
May I suggest a few off-the-cuff contemporary indicators to illustrate the ‘external’ effect:
1. New globalisation and intense proto-capitalist spurts by millions of efficient low-cost producers in China and elsewhere, with the consequent global labour effect.
2. Patterns of European (dis)integration and restructuring, the denialism characteristic of democratic citizenry, and prolonged refusals to accept structural economic and institutional reforms.
3. Socio-political dynamics related to overloading of state welfare systems in the West.
4. The interplay of 1, 2, 3 with financial bubbles and unprecedented debt-to-GDP ratios.
5. Twenty-first century wars fought by drones, unrest in the Middle East and then in Asia.
6. The extraordinary influence of new media, and the superficiality of economics-as-entertainment.
Schumpeter mentions wars, “the annihilation of Russia” (perversely it is being repeated today by Putinism), “impediments to the working of the gold standard” (passé), and “economic nationalism heaping maladjustments upon maladjustments” (everywhere). Most relevant to the present situation in 2013 are “fiscal policy incompatible with the smooth running of industry and trade”, “mistaken wage policy”, “political pressure on the rate of interest”, and, as I mentioned above, the “organised resistance to necessary adjustment”.
The external factors are what distinguish one depression from another. When we say this time is different, we mean contextual “non-economic causes which play the dominant role in its drama”. Underlying economic causes of depressions are universal, always essentially the same.
Instead of thrashing about intellectually or emotionally as we “reapportion our blame for what has happened between the business and the political world”, or while we “take melancholy satisfaction” in claims to “verification of some of the oldest teachings of economic science”, we should quickly come to terms with external national and global social, political, or institutional factors which are “the cause of the impossibility to forecast”.
Then comes the Schumpeterian crunch: “What we face is not merely the working of capitalism, but of a capitalism which nations are determined not to allow to function. This may be, and probably is, inevitable. But it is the greatest difficulty in the way to recovery.”
3. So, What Is To Be Done?
Having sharply lowered our expectations for easy solutions and a short-run return to normality, Schumpeter goes on to note several “problems” that complicate the policy response.
“First, removal of extra-economic injuries to the economic organism: Mostly impossible on political grounds.” [Translation - it’s incredibly difficult to persuade Greek or French voters, or Obama’s constituency, or Japan’s LDP factions, of the need for structural reform.]
“Second, relief: Not only imperative on moral and social grounds, but also an important means to keep up the current of economic life and to steady demand, although no cure for fundamental causes.” [Translation - were it not for Keynesian and market monetarist extremism, safe levels of monetary and fiscal relief could be negotiated to preserve the modicum of socio-economic stability during painful Gladstonian retrenchment.]
Please note that in 2013, unlike 1933, the state protects the unemployed. This time really is different because capitalism now functions with automatic anti-suffering stabilisers.
“Third, remedies: The chief difficulty of which lies in the fact that depressions are forms of something which has to be done, namely, adjustment to previous economic change. Most of what would be effective in remedying a depression would be equally effective in preventing this adjustment. This is especially true of inflation, which would, if pushed far enough, undoubtedly turn depression into the sham prosperity which would, in the end, lead to a collapse worse than the one it was called in to remedy.” [The same might now be said for austerity, which obviously is necessary, but if taken alone and to extreme is a sham remedy.]
As the reader is undoubtedly left wondering where exactly the policy response lies in all of this, I am forced to summarise by jumping disjointedly to the end of Schumpeter’s essay:
“There is no reason to despair -- this is the first lesson to be derived from our story … In all cases, recovery came of itself. But this is not all: our analysis leads us to believe that recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds new maladjustment of its own, which has to be liquidated in turn, thus threatening business with another crisis ahead. Particularly, our story provides a presumption against remedial measures which work through money and credit.”
Charles Darwin had a hard time getting his message across. Schumpeter, because he theorised the evidence for evolutionary patterns in economic history, and had no simple story to tell, is the Darwin of economic science. Keynes’s reputation, by comparison, rests on ahistorical models that require prolonged high doses of economic faith in intelligent design. The danger lies both in their cumulative effect and large risk of overdose.