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The Current Financial and Economic Crisis:

A Systemic Crisis of Neoliberal Capitalism

David M. Kotz

University of Massachusetts Amherst

May 18, 2009

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1. Introduction

This crisis is not just a financial crisis.

It is not just a severe recession.

Rather, it is a crisis of the neoliberal form of capitalism itself.

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A Systemic Crisis

1) The crisis emerged not just from financial deregulation but from the whole set of institutions that have made up the neoliberal form of capitalism.

2) The crisis cannot be resolved within the framework of neoliberal capitalism.

Thus, neoliberal capitalism cannot be revived at this time.

If this view is correct, then major economic restructuring is required before the global economy can be restored to a healthy condition.

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Earlier systemic crises

1) 1930s: An earlier liberal form of capitalism went into crisis following the stock market collapse of 1929.

2) Mid 1970s: The state regulated capitalism of the post-World War II decades stopped working effectively.

In both cases, the crisis was followed by a thorough restructuring of capitalism.

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Outline

1. How the neoliberal form of capitalism has been able to promote high profits and long economic expansions for several decades in the U.S.

2. How the same processes that promoted profit-making and capital accumulation led to a systemic crisis, which broke out in 2008.

3. Possible directions for economic restructuring.

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Neoliberal Capitalism in the USA

1. Deregulation2. Privatization3. Renunciation of Keynesian macro-

regulation 4. Reductions in social spending5. Tax cuts for business and the rich6. Attack on trade unions7. Shift to temporary and part-time workers8. Unrestrained competition

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Three Developments

The features of neoliberal capitalism gave rise to 3 developments:

1) Growing inequality

2) Financial sector increasingly devoted to speculative, high-risk activities

3) Series of large asset bubbles

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Figure 1. Growth Rates of Output per Hour and Real Average Hourly Earnings of Nonsupervisory Workers

1.44%

2.04%

2.45%

1.91%

-0.85%

0.49% 0.49%

-0.04%

-1.50%

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

1979-90 1990-2000 2000-07 1979-2007

Period

Ave

rag

e an

nu

al p

erce

nta

ge

rate

of

chan

ge

Output per hour Average hourly earnings

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Figure 3. Growth Rates of Profit and Compensation

2.6%

4.4%

8.2%

4.6%

1.7%

3.1%

1.0%

2.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

1979-1990 1990-2000 2000-2007 1979-2007

Period

An

nu

al a

vera

ge

per

cen

tag

e ra

te o

f ch

ang

e

Growth rate of profit Growth rate of compensation

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Large Asset Bubbles

1980s: An asset bubble arose in Southwestern commercial real estate.

This led to the collapse of a large part of the savings and loan industry and then its bailout in 1990.

1990s: A very large asset bubble emerged in the US stock market in 1995.

In 2000 that asset bubble collapsed. 2000-07: A huge asset bubble started

growing in the housing sector around 2002.

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Housing Bubble

At the peak of the housing bubble in 2007:

Estimated inflated new housing wealth: $8 trillion.

Total housing wealth: $20 trillion

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Roots of these 3 Developments

1. Inequality: All of the features of neoliberal capitalism contributed to the rapid growth of inequality.

Neoliberal institutions greatly reduced workers’ bargaining power.

2. Speculative, high-risk financial sector: Result of Financial deregulation

Unrestrained competition

Speculative investments are much more profitable than traditional financial activities.

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Speculative, High-Risk Financial Sector

The share of the profits of financial institutions in total corporate profits:

1979: 21.1%

2002: 41.2%

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Asset Bubbles

Asset bubbles were the result of first 2 developments

Huge and growing profits led to more investable funds than the available productive investment opportunities.

The deregulated financial sector was eager to lend for speculative purposes.

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Neoliberalism and Long Expansions

Rapid growth of profits produced a strong incentive to expand production.

Problem: Who will buy the growing output?

Someone had to spend more than their income.

Asset bubble provides the collateral.

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1990s Stock Market Bubble

The 1990s stock market bubble stimulated rising consumption by upper income households.

They borrowed against their rising securities wealth.

This permitted consumer spending to rise faster than GDP during 1997-2000, which prolonged the expansion.

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2000s Housing Bubble

The 2000s housing bubble enabled millions of homeowners to borrow money against the rising value of their homes.

This made it possible for consumer spending to rise faster than households’ disposable personal income.

This made the 2000s economic expansion possible despite stagnating household income.

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Figure 5. Gross Equity Extracted as a Percentage of Disposable Personal Income

2.6% 2.4%2.2% 2.0% 2.2%

2.7% 2.8%

4.4%4.7%

4.3%

5.7%

8.2%7.8%

10.3%

9.2%9.0%

6.9%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

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Expansion of 2000s

Solving the demand problem

Asset bubbles provided the collateral for borrowing, enabling spending more than income.

The speculative financial sector provided the supply of loans.

Loans to low-income households seemed safe due to rising home prices.

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Expansion of 2000s

Inequality guaranteed a demand for loans.

As millions of families struggled to pay their bills, banks offered to lend them money against their home.

The mortgage loans appeared to have easy terms, but the payments usually increased greatly after 2 years.

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Crisis

The character of the long expansions under neoliberal capitalism gave rise to unsustainable trends:

1. Growing household debt

2. Growing financial sector debt

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The Role of Household Debt

A system in which wages are held down so severely that economic expansion is possible only through growing household debt cannot continue indefinitely.

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Figure 6. Household debt as a Percentage of Disposable Personal Income

128.8%

91.1%

59.0%

77.5%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

110.0%

120.0%

130.0%

140.0%

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The Role of Financial Sector Debt

The financial sector debt grew even more rapidly than the that of the household sector.

This resulted from financial institutions seeking to increase their profits through leverage (borrowing).

The result was increasing “financial fragility.”

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Debt as Percentage of GDP

0%

20%

40%

60%

80%

100%

120%

140%

1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

Year

Perc

enta

ge

Fin Debt/GDP NFC Debt/GDP HH Debt/GDP

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Unsustainable Trends

As trillions of dollars in risky mortgage-related securities spread through the U.S. (and global) financial system in the mid 2000s, the financial system became ever more vulnerable to a deflation of the housing bubble.

As is the case with all asset bubbles, the housing bubble of the 2000s was bound to deflate at some point.

Once the housing bubble began to deflate, all of the foregoing trends would become unsustainable.

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Unsustainable Trends

In 2006-07 the housing bubble started to deflate.

Millions of homeowners could no longer make the payments on their mortgages.

As a result, the value of mortgage backed securities collapsed.

The increasingly fragile fin sector could not survive the deflation of the housing bubble.

The collapse of the housing bubble brought the neoliberal era to a close.

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Real Sector Recession

The housing bubble deflation is the main immediate cause of the recession.

As the bubble deflates, consumer spending and residential investment contract.

This has a secondary impact on business fixed investment.

With income falling, export demand is falling throughout the world economy.

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Real Sector Recession

The underlying cause of the real sector recession is over-investment due to the stimulation of consumer spending by asset bubbles.

Since the housing bubble is likely to take several years to fully deflate, this process is likely to continue for some time.

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Systemic Crisis

Another expansion within the neoliberal model would require

1) A new asset bubble.

2) A financial sector able to supply loans to support the bubble and rising borrowing for consumer spending.

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Possible Directions of Restructuring

1. Corporatist form of capitalism

2. Social democratic form of capitalism

3. Socialism

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Corporatist Form of Capitalism

1. State regulation of the financial sector2. Capital-labor relation that keeps wages low3. Big state spending program a) infrastructure and technology b) military and “national security”4. Global Institutions: a) continuation of low barriers to exports of

goods and direct foreign investment, but perhaps controls over financial capital movements.

b) US efforts to maintain domination of the global system but in cooperation with its main allies.

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Social Democratic Form of Capitalism

1. Capital-labor compromise allowing rising wages.

2. Restrained competition.

3. Expanding state spending for social and environmental purposes as well as infrastructure.

4. Regulated financial sector.

5. Changes in institutions at the global level consistent with social democratic institutions at the national level.

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Socialism Moves onto the Agenda?

Neoliberal capitalism has worsened conditions for the majority for 30 years.

The financial & economic crisis is showing capitalism at its worst.

Millions of people are facing unemployment, loss of their home, loss of their savings.

Society faces the threat of global climate change.

A socialist alternative to capitalism may move onto the political agenda due to the obvious failure of capitalism to meet the needs of the majority.