“Cyclical” Unemployment – Part 5 of ‘Unemployment and Revolution’ (by Albert Langer in 1981)

Part 5: “Cyclical” Unemployment

– Anarchy of Production
– Planning and Money
– Profitability
– Overproduction
– Are Wages Too High?
– Stimulating Demand
– Economic Crisis

5. “CYCLICAL” UNEMPLOYMENT

Well, we have established that the normal adjustment mechanisms in the labour market will not necessarily eliminate unemployment, and we have shown that the unemployment we have now is not “technological”. We have conceded that there is a “real wage overhang” but not conceded that lower real wages would reduce unemployment. We have not yet answered the question of why things have changed from the “normal” regulation of unemployment, nor what can be done about it.

We will now attempt to explain what is meant by “cyclical” unemployment and how this involves a “crisis of overproduction”. Unfortunately the explanation below is not very clear or complete. Generally a good test of whether you really understand something is how well you can explain it to others. So I guess I am not very clear on this stuff myself. Any queries and comments on the following material would be especially welcome.

First of all, what’s new? Why is the labour market not regulating unemployment like it used to? The conventional wisdoms about unemployment just take it for granted that since there is something wrong with the labour market then both the cause of the problem and the solution to it must also lie in the labour market. But in fact they do not, because unemployment and wage rates are not the only things out of kilter.

The labour market is not operating normally because forces outside the labour market have changed the way in which jobs are being created and destroyed. We must therefore look outside it to explain those changes.

Unemployment is part of the mechanism that regulates wages, prices, the rate of profit and the balance between production, consumption and investment. However it would be a gross oversimplification to pretend that it is the sole, or even the main factor.

Unemployment is not even the only factor regulating wages, let alone regulating the economy as a whole. In addition to the labour market, other markets are also out of balance.

Commodity prices are at record levels and still rising, financial markets have record interest rates, foreign exchange market are all over the place, and so on. Something has really gone quite wrong, and it is something that effects all aspects of the economy.

We will argue that what is wrong is “overproduction”. The fundamental cause is the basic anarchy of a market economy. Nothing very much can be done about it except passing through another major economic crisis – or overthrowing the system and building a new one.

Anarchy of Production

It is often assumed that the output of capitalist industry is simply divided between wages and profits.
From one side this leads to the idea that profitability can be simply restored by cutting wages. From the other side it leads to the idea that increasing wages would “stimulate demand”. Once again we have both “left-wing” and “right-wing” prescriptions resting on the same faulty analysis.

In fact only a small part of the total output of industry goes into consumption goods purchased either from wages or profits. The bulk of the output consists of means of production which are used either to replace those used up in the previous period, or for investment in expanding production in the next period.

The “Gross National Product” is not the total output, but output net of all the intermediate products produced and consumed in further production. Even the GNP includes investment as well as consumption. Cutting wages will not solve the problem of realising profits by selling the total output on the market. The product has to be sold before the proceeds can be divided up between wages and profits.

Raising wages also will not solve that problem. Most of the total output is bought by capitalists as means of production, and their ability to buy it depends critically on profits, which would be reduced further by raising wages.

For reproduction to proceed smoothly, the demand for means of production as replacement and new investment must provide a market for those means of production that have actually been produced. The profits made selling goods and services on the market must provide the investment funds to buy them on the same market. Surplus value is produced when products are made, but profits are not realised until the products are sold.

The demand for consumer goods and services by capitalists and workers must correspond to the consumption goods that have been produced. The increase in demand for consumer goods from one period to the next must correspond to the investment that has been made in the previous period to meet that demand. The investment in industries producing consumer goods depends on previous investment by industries producing the necessary means of production, and so on.

Not only the profits, but the cost of production itself, can only be realised if the products are sold on the market. The sale of each firm’s output depends on some other firm (or consumer), buying these products as inputs. The money to buy the inputs depends on the sale of the outputs.

Production has become highly socialised, with every firm directly or indirectly dependent on every other firm through the immensely complex social division of labour. The gigantic means of production operated by huge labour forces are geared to production for the whole of society. They are basically social means of production only useable in common. Yet the physical exchange of necessary inputs and outputs between different establishments is entirely dependent on free market relations.

Any disproportions will result in goods unsold, profits unrealised and investments not made – whether wages are high or low. Sever disproportions will result in suppliers unpaid, bankruptcies and market collapses. This cannot be rectified simply by cutting wages, if there is no market for what has been produced.

In a full scale crisis, products can be virtually unsaleable at any price,and may be dumped on the market by bankrupt firms unable to pay their creditors. Not only can profit margins become too small, and then disappear entirely, but the value added can disappear too, so that production would not be worthwhile even with zero wages. *In fact the value of raw materials (plant and stock) etc can also disappear so that a finished product will fetch more as scrap for its component materials than it will on the oversaturated market for that product. Whole steel plants and shipbuilding yards were scrapped in this way during the last depression.

What ensures that the proper proportions will be maintained so that exactly those goods are produced that are required? Very simple. It is a market economy, so the market regulates it. If demand for a particular product exceeds supply, the price will go up. If production becomes more profitable than average, capital will be attracted to that industry instead of others. Profit is what regulates the economy and profit is all that regulates it. The miracle is not that this sometimes breaks down in a crisis, but that it ever hangs together at all!

Planning and Money

Actually of course, things are not quite that fragile. There is a lot of leeway because firms can go on producing even at less than the average rate of profit, so long as they do not make a loss. They can even bear a loss for some time, as long as they do not go bankrupt. They can even keep trading after they have become insolvent, as long as nobody knows. Goods that are not sold to final buyers can still be sold to wholesalers, or accumulated in inventory.

The credit system is extremely flexible and can be stretched to cover disproportions in particular sectors, and also in the economy as a whole. This is a major topic in itself, quite central to understanding overproduction and crises, but unfortunately it can not be covered here.

But all this leeway and flexibility also implies that disproportions can continue developing for some time before they break out in a crisis.

It will seem to highly profitable firms that their market is still expanding, when actually the demand is coming from firms that are already operating on reduced profit margins, or are insolvent, and from wholesalers which are not actually able to sell the goods to final buyers, and so on. Faced with this apparently “expanding” market the profitable firms will expand their investment, which in turn stimulates demand in other sectors and keeps the whole boom going. But the margins get narrower, credit gets tighter and eventually the whole thing blows up *(implodes).

Another aspect is that production is far more planned than it used to be. Whole sectors of the world economy are each under the management of a single centralised transnational corporation. Governments and international organisations play important co-ordinating and planning roles. There are serious efforts to predict the demand, supply and prices of everything that is produced, and to use these predictions for quite long range planning of production and investment.

But these forecasts and plans still revolve around the market. Nobody allocates the total social product between the different sectors of industry and individual establishments. They buy and sell it from each other because they each privately own a different part of it. Their relations are money relations.

When money breaks down, the “social fabric” unwinds, because money is the social fabric of a market economy. The more large scale and long term the plans, the more fundamental the disproportions that can develop before the crisis actually breaks out.

Again, we need to study the essential nature of money to understand why it breaks down in a crisis, but that will not be gone into here. We tend to take money for granted, as though it is perfectly natural that everything produced should have a price. Yet the social relations expressed by money are extremely difficult to grasp and absolutely fundamental to the nature of market economies.

Profitability

If any single regulator can be considered decisive in a capitalist economy, it is the real average rate of profit. This is what determines the flow of investment from one sector to another and regulates a balance between production and consumption. Wages are one factor influencing profitability, but others are just as important.

In “equilibrium”, higher wages means lower profits, but we are now discussing “disequilibrium” and very often the same factors that push profits above and below their “natural” rate, will push wages in the same direction, until the underlying real movement forces a change in direction for both.

What determines the creation and destruction of jobs is the extent and labour intensity of investment. Investment depends on profitability, in which wages are only one factor. The price at which the output can be sold is just as big a factor.

Over the whole period of the capitalist business cycle we find a general trend up and down in the rate of profit with corresponding trends in employment, prices, interest rates and so on. When the business cycle lasted only five or ten years, these movements were very obvious. But since we have not had a full scale crash since the 1930’s, the changes appear to be long term secular movements rather than features of a business cycle.

Yet the usual pattern can be seen of an apparent high rate of profit with rising prices followed by overproduction, falling profit margins, increasing unemployment and so on.

A characteristic feature is the gradual stretching of credit as overproduction intensifies, until the whole structure becomes top heavy and topples over. While Keynesians are clamouring for more credit expansion, the structure of debt has already become far more top heavy than in any previous period. Most corporations now run on ratios of debt to equity in excess of 80%. There is no room for the slightest drop in prices and profitability without actual bankruptcy.

Another feature is the gradual increase in unemployment until the actual crisis breaks out and intensifies unemployment enormously. This unemployment is “cyclical” because it reaches a peak at the depths of a depression and is a minimum at the height of prosperity. It reflects an overall state of demand in the economy that moves quite differently from the “normal” regulation of wages and unemployment during the phase of prosperity.

There is not the slightest sign of a reversal in these trends and no reason to believe they can be reversed except by the outbreak of a full scale crisis. Just as the labour market is unregulated and must correct its own fluctuations, so there is no overall authority that can ensure a balance between production and consumption, savings and investment, borrowing and lending. In general terms, production creates its own market, and it is theoretically possible for capitalist production and accumulation to continue indefinitely. Theories of “underconsumption” are quite wrong.

But periodic overproduction is inevitable, for reasons explained here. It is only the overproduction itself, and its effect on the rate of profit, that can bring into play the mechanism for restoring a balance. The mechanism for restoring a balance is a collapse in the rate of profit, that is to say, the balance is restored by having an economic crisis.

Overproduction

During a boom, excess demand pulls up prices, including wages, and there is an overinvestment of capital so that more capital is being invested than can ultimately return the expected rate of profit.

More workers may also be attracted into the labour force. This may go on for a long time, with various ups and downs, as the demand for investment goods and services feeds itself, and as credit is stretched.

Each firm can only estimate its market from previous trends and price movements. It has no “guaranteed buyers” for the same reason that labour does not. Planning must proceed on the basis of an assumed expansion of markets, and generally that assumption is self-fulfilling.

The general expansion of investments itself creates a market for the goods produced and allows the expansion to continue. *Every firm is continuously engaged in a relative overproduction, producing more than it knows it has a market for. Yet while the economy is expanding generally, the consequences of a miscalculation will only be a local loss of profits and not bankruptcy or market collapse.

As long as business is brisk, capitalism hardly seems to be obstructing the growth of the productive forces at all. There is no barrier to production beyond the capacity of labour, natural resources and existing plant and stockpiles to produce more goods. But eventually the shit hits the fan and plant is installed to produce goods and services that just cannot be sold at the expected profit margins.

Then the nice “demand pull inflation” that was stimulating increased production turns into nasty “cost push inflation” with the opposite effect. It has to, since one firm’s costs are another firm’s demands. All that can postpone the equation between input “costs” and output “prices” is continued intensification of the excess demand of the boom, and the same factors that postpone it must intensify the crash when it comes.

It turns out then that there is a barrier to capitalist production, namely profitability. Goods can only be produced if they can be sold for more than it cost to produce them. When too many are produced to keep prices at that level, profits disappear and so does production.

It turns out then that for a long time investment has been taking place in the wrong proportions between the sectors producing consumer goods and those producing means of production. More should have gone to producing the means of production for producing more means of production. Less should have gone into directly producing consumer goods because the market there is mainly wages and the workers are not very rich.

But this could not have been noticed before, because production was being expanded more or less uniformly on the assumption of uniformly expanded demand. Why should anyone think that capitalist production has to produce a higher and higher proportion of means of production instead of a balanced output including the final consumer goods themselves?

When the boom stops feeding itself and stops being fed, there is a sudden collapse in the rate of profit and a “crisis of overproduction”. Consumer goods sectors crash because there is not a market for the amount that has been produced (not that we could not benefit from a higher standard of living, but we have not got the money to pay for it). Sectors producing means of production also crash because nobody is buying means of production to expand their capacity to produce goods that cannot be sold.

In the subsequent “bust”, wages are one of the things that have to come down before a new boom can begin, but a lot of other adjustments have to occur too. The crisis involves destroying or devaluing a large part of the overinvested capital and restructuring the whole economy.

When the crisis is over, capital has been restructured in favour of means of production so that much more productive techniques are used, with a higher organic composition of capital. This lays the basis for the next boom with a much higher standard of living than the last one.

Monopoly capitalism is much more flexible than laissez-faire capitalism and has mechanisms for relatively smooth variations of output to correspond to demand. Minor fluctuations will not produce large price movements or great changes in installed plant capacity, but only changes in plant utilisation, inventory levels, and credit stretching. As with the labour market and unemployment or labour shortages, these flexible mechanisms have to already be stretched considerably, before disproportions will actually show up as overproduction and reduced profits.

Even more stretching is required before overproduction could result in the sort of market collapse that used to occur quite regularly in the days of laissez-faire. But since there is no other overall regulator, that stretching is bound to occur, until it does produce the crisis needed to restructure the economy and restore a balance. Since the end of laissez-faire capitalism, crises have been much less frequent but far more devastating, when the flexible limits are eventually overstretched.

Are Wages Too High?

In the period between boom and bust, it is possible for the share of wages in GNP, and real wage costs per unit output, to be higher than usual, even while real wages are falling and unemployment is growing. Conservative economists conclude that this must be the cause of the problem, and the solution must be to push real wages down faster.

But wages appear to be “high” because profits are low. Real profits are falling because overproduction means the goods cannot be sold at their usual profit margins, even if nominal accounting profits at inflated prices are still “record”. This alone implies a higher relative share for wages. The real problem is how to raise profits, and that depends more in this case on prices than wages.

If there was simply a “fluctuation” in demand, with a smooth corresponding adjustment of production and employment, then there would be no problem. Real wage costs would not depart from their normal trend. This has been the experience in previous recessions in Australia, such as 1951-52 and 1960-61. But “overproduction” implies that the unsaleable goods have actually been produced, or the plant capacities to produce them have actually been installed, so that profit levels remain depressed and the ratio of wages to output is changed.

Overproduction implies that the prices of firms’ outputs cannot go up fast enough compared with the prices of their inputs, and this is described as “cost-push inflation” rather than the “demand-pull inflation” of the boom. But it really reflects a situation where there is not a sufficient market for the goods that have been produced. The result is excess capacity as firms cut back their production to keep prices up, and lower labour productivity since the labour force is not reduced in proportion to the restriction in production.

This lower labour productivity resulting from capitalist anarchy becomes the subject of sermons to the workers on not being too greedy. The underlying cause of changes in the relative share of labour in the GNP and the real cost of labour per unit output, is the overproduction and overinvestment, not any imbalance in the labour market. Nevertheless, the effect is similar to labour shortages having driven up wages (which indeed is one of the many things that does happen when overinvestment reaches its peak at the height of the boom),. The response is a slackening in job creating investment and increased unemployment.

One feature is that investment can become more capital intensive than normal, based on the apparently high real cost of labour per unit output. This can destroy jobs faster than they are being created. The unemployment created in this way can and does produce lower real wages since it implies a “slacker” demand for labour. The normal operation of the labour market, will bring down wages until this particular source of increased unemployment is no longer operating, even though the apparently high relative cost of labour is due to output restrictions rather than high real wages.

But the more important reason for growing unemployment is that since profit margins are not high enough on the overproduced goods, there is a lack of funds for any investment that would create new jobs at all – whether labour intensive or capital intensive.

Will Lower Wages Reduce Unemployment?

Lower real wages cannot increase employment since high wages were not the cause of investment drying up. So the apparent imbalances in the labour market continue growing and unemployment continues increasing without being able to produce any equilibrium.

Indeed it is even possible for real wages to rise during a depression, despite mass unemployment. This can occur because it is not wages, but markets, that are limiting investment and employment. Firms can continue their (reduced) production levels despite high wages, and will not expand production and increase employment just because wages come down. Unemployment exerts a downward pressure on wages, but since the employers demand for labour is not highly dependent on wage levels, that pressure can be counteracted.

Wage rates are determined far more by variations in the demand for labour with price than by variations in its supply. Thus the predictions of orthodox economists have been totally confounded by the simultaneous expansion of female employment together with equal pay, and by the trade unions present capacity to fight for shorter hours and higher wages despite more unemployment.

In both these situations we have a level of demand for labour that is not sharply dependent on its price. The first during a boom and the second at the end of one.

Even when the demand for labour is falling, it need not produce a fall in wages unless the demand depends on the wage rate. A firm that has already cut staff to reduce output and has excess capacity, will not necessarily cut staff further if wages go up. The same output will still be required to maximise profit, and the same staff will be required to achieve that output, even if profit is further depressed by increasing wages.

Thus even while the total demand for labour is reduced, that demand may become less “slack” – less variable according to wages, and the bargaining position of workers who are still employed may actually improve. Wages can still rise to the point at which it becomes more profitable to use less labour intensive techniques, or to cut back production and employment further. Given excess capacity, there may be considerable room for wages to rise before either of those points is reached.

Here the distinction between “slack demand” and “unemployment” as a cause of falling wages becomes important. Real wages actually rose at times during the last depression, despite mass unemployment. They also rose sharply during the “wages explosion” of 1974, despite increasing unemployment. They have still not fallen a great deal. The conventional conservative theory of wages and unemployment finds it difficult to account for these facts and compensates for this difficulty by hysterical attacks on unions.

Mass unemployment can compel a reduction in real wages, after working class organisation has been smashed. It can do this by compelling workers to accept wages that are less than the value of their labour power (ie less than the “marginal product” of labour they can obtain as unionists selling at a monopoly price). But that in itself is not enough to restore equilibrium. Unemployment will continue until the overinvestment and overproduction has been worked out of the system. More drastic cuts in real wages will not change the fact that goods are not being sold profitably enough for new investment to absorb the unemployment.

Further cuts in real wages will certainly increase profits, and will be welcomed by employers, but no amount of cuts can make investment profitable when there is no market for more goods. Even at zero wages, nobody is going to build new car plants, when the cars already produced are piling up unsold, or are being sold at low profit margins. More cars may be sold because they are cheaper with lower wages, but not enough more to absorb the excess capacity and encourage new investment. The lower wages will simply increase profits without increasing investment. By keeping up wages in a depression, unions are not doing the unemployed out of a job, but simply depriving capitalists of surplus profits.

Stimulating Demand

Keynesians argue that excess production capacity implies a “slack” in the economy which leaves room for employment to be increased by government action to stimulate demand, without necessarily pulling up prices. But this misses the whole point of the adjustment mechanisms that have produced the excess capacity in the first place.

Excess capacity has appeared because market demand does not allow firms to raise their output prices enough to maintain profit margins. Any stimulation of demand must therefore produce a rise in prices before it will produce an increase in output. There would be “slack” if plant was being underutilised because of a fluctuation in demand and the normal adjustment to it. But there is no “slack” when profit margins have already fallen. There is just “excess capacity”.

Once excess capacity has appeared, attempts to stimulate demand by extending credit with the budget deficit, amount to buying up the overproduced goods on the “never-never”. Extending credit means extending debt. Ultimately there has to be a real market or the postponement of bankruptcy by extending credit only adds to the size of the crash when it finally comes.

That of course may not be such a bad thing. There is no harm in demonstrating what heights of prosperity could be achieved by the permanent boom of socialism at the expense of a deeper crash by capitalism when it fails to maintain that prosperity. But we are already at a stage where the credit has been rather fully extended. While governments should and will continue to extend it as long as they can, that may not be all that long. Governments go bankrupt too.

Economic Crisis

The next phase of the business cycle, which we have not seen yet, involves market collapses to restructure production and get rid of the overinvestment. This is not the place to enter into a detailed analysis of the nature of capitalist crisis, and the particular characteristics and timing of the coming one. This would also involve considering the expansion and contraction of credit, the operation of financial and capital markets and so on. It would also be necessary to explain inflation and the real and apparent movements of relative prices. In any case I do not understand it well enough to say much more.

But the implication of all this for unemployment is simple. The whole world economy is out of balance and only an overall crisis will restore that balance. It is not just a matter of pushing down wages until the labour market is back in balance. Nor are there any other easy solutions.

At the moment we have both rising prices and growing unemployment and that is seen as a unique phenomenon different from any previous cycle of boom and bust. But in fact it is simply a more long, drawn out version of the usual pattern. The boom has basically ended and unemployment has started to grow. But the “bust” has not happened yet and we have not yet got a real crisis or massive unemployment. There is still real economic growth and rising prices and even room for some renewed mini-booms because the next phase of the business cycle has not yet begun. During the late 1920’s unemployment also started to rise while prices were still going up and before the actual crash.

The “price mechanism” we learn about in orthodox economics textbooks does work. A market economy, a capitalist economy, can develop the productive forces to higher and higher levels without central planning. But a pool of unemployed fluctuating between small and large is an essential part of how it works. The price mechanism does not prevent market collapses and economic crises. Crises are an essential feature of the way it works. Booms end in busts and busts pave the way for booms because there is no other regulatory mechanism in a market economy.

The “balancing mechanisms” and regulators of a market economy all sound quite neat and clever. But they are proving extremely destructive. What an incredibly archaic way to regulate an economy in this day and age!

The Great Depression of the 1930’s was the only way that the “roaring twenties” could end. That depression and the Second World War paved the way for unparalleled prosperity in the 1950’s and 1960’s. The post war boom was longer and reached greater heights than any previous boom in the history of capitalism. The period of teetering on the edge between boom and bust has been longer than any previous such period in history. We can reasonably expect that the coming crisis and depression, which is certainly not here yet, will be very much deeper than the 1930’s.

(Next instalment: ‘Solutions’)

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