Finance Capital and Fiscal Deficits
by Prabhat Patnaik
One of the central paradoxes in economic theory relates to the hostility
that financial interests in a modern capitalist economy systematically
display towards any policy of enlarged State expenditure financed by
borrowing, even though such expenditure increases capitalists' profits and
wealth.
Let us suppose that the government undertakes a larger borrowing-financed
public expenditure programme, and that all borrowing is from domestic
sources. Then corresponding to the increase in government borrowing, there
must be an equivalent increase in the excess of private savings over private
investment. Since private investment expenditure is more or less given in
any period, a result of past investment decisions, a rise in government
borrowing creates an equivalent increase in private savings. Since such
savings depend upon post-tax profits (surplus), there must be a rise in
post-tax profits (surplus); and what is more, this rise is some multiple of
the rise in government borrowing.
An example will clarify the point. If, say, one-half of post-tax private
profits (surplus) is habitually saved, then a rise in government borrowing
by Rs.100 at base prices will raise private surplus by Rs. 200 at base
prices in order to generate Rs.100 of private savings to finance itself.
This will happen in a situation of less than full employment through an
increase in output and employment, while the base prices themselves remain
more or less unchanged; in a situation of "full employment" (supply
constraint) this will happen through profit inflation squeezing out "forced
savings" from the workers. The capitalists as a whole in other words earn
an additional amount that is a multiple of the increase in government
borrowing.
In his book How to Pay for the War, the well-known English economist John
Maynard Keynes had called this additional profit of the capitalists "a
booty" that fell into their lap. He was talking about increased government
borrowing to finance war expenditure in a situation where the scope for
raising output and employment was limited, and he was assuming that the
whole of the additional profits accruing to capitalists was saved. In such
a case, if government expenditure rose by Rs.100, then there would be
inflation that would squeeze workers' consumption, and simultaneously boost
profits. Hence, while the actual resources for meeting war expenditure came
from the workers whose consumption was reduced by an equivalent amount, the
capitalists' wealth increased by Rs.100 despite their having done nothing.
It is as if the government snatched away Rs.100 from the workers, put it in
the lap of the capitalists, and then borrowed this Rs.100 from them. The
real "sacrifice" for the war in other words was made by the workers, while
capitalists' wealth went up gratuitously. The "unfairness" of this had
prompted Keynes to argue that even if the government had to snatch away
Rs.100 from the workers, the capitalists must not be handed over this amount
as "booty", i.e. war expenditure must be financed through taxes.
In Keynes' example, supplies could not be increased and hence the rise in
profits occurred through inflation. But if supplies can be increased then
larger government borrowing still increases the magnitude of profits, but
through an increase in output not prices. Larger government borrowing in
short invariably boosts capitalists' profits and wealth.
But this brings us back to the question that if a borrowing-financed
increase in government expenditure hands over a "booty" to the capitalists
that is some multiplier (greater than or equal to one) times this
expenditure increase, then why are the financial interests opposed to such
an increase? Why for instance do they favour the principle of "sound
finance" and insist on the passage of Fiscal Responsibility Legislation
everywhere to limit the size of the fiscal deficit?
One can give certain obvious economic explanations. The first is the fear
of inflation. Larger government expenditure by raising the level of
aggregate demand will cause inflation which will lower the real value of all
financial assets, something which finance capital obviously dislikes. This
explanation is not without weight, but it fails to explain why the
opposition to borrowing-financed government expenditure should persist even
in the midst of a Depression when the increase in aggregate demand is likely
to cause almost exclusive output adjustment with very little impact on
prices.
The same holds for the other possible economic explanation for their
opposition, namely a fear of worsening of balance of payments and hence of a
depreciation of the currency, which again would lower the value of financial
assets, but in terms of other currencies. A whole lot of measures, however,
ranging from import controls to increased external borrowing, are available
to the government that is stimulating the economy. These measures can keep
the fear of any currency depreciation at bay. The fear of currency
depreciation therefore cannot also be an adequate explanation.
It follows then that economic explanations for the opposition of finance to
increased borrowing-financed government expenditure are inadequate. The
real basis of the opposition is political. As the Marxist economist Michael
Kalecki had once remarked, profits are not everything for the capitalists;
their class instincts too are important. And these class instincts tell
finance capital that a proactive expenditure policy of the State, even for
the purpose of demand management, is detrimental to the long-term viability
of the system in general, and of the financial class in particular.
The mythology propagated by capitalism is that the unfettered functioning of
the system gives rise to a state of full employment where the resources are
efficiently allocated. This myth of course cannot be sustained, since even
the most die-hard believer in the ideology of capitalism cannot deny the
real-life existence of periodic Depressions and the virtually perennial
state of demand-constraint that afflict the system. Depressions are usually
explained in bourgeois theory in terms of a setback to the "state of
confidence" of the capitalists. It follows then according to bourgeois
theory that if a capitalist economy is doing poorly then the remedy for it
lies in providing greater support and concessions to the capitalists so that
their "confidence" will revive, and with it the economy.
But if government expenditure can be used to revive the economy, then "the
state of confidence" of the capitalists ceases to be of paramount
importance. The very fact of the economy's revival will itself, if
anything, bolster their "state of confidence"; and even if their "state of
confidence" is not revived fully, the government can still stabilize the
economy at a high level of employment. What is more, since the adverse
effect of government measures for reducing income and wealth inequalities in
society, like profit taxation or property taxation, on the "state of
confidence" of the capitalists, can be counteracted by government
expenditure, so that unemployment need not result from such measures, the
government can adopt them with impunity. Thus a government that can use
public expenditure to sustain the level of activity in the economy need not
bother much about the "state of confidence" of the capitalists and hence can
bring about far-reaching changes in the system, including, where necessary,
the induction of public enterprises.
There is no reason why such public enterprises should be any less
"efficient" than private enterprises in an engineering sense, i.e. in terms
of physical input use; but even if perchance they are, an economy, with
public enterprises, functioning close to "full employment" will still have a
larger volume of goods at its disposal for given input endowments than a
free market capitalist economy. In short the "social legitimacy" of
capitalism gets seriously compromised by the fact that State expenditure can
take the economy to near-full employment irrespective of the "state of
confidence" of the capitalists.
In a modern capitalist economy the barometer for the "state of confidence"
of the capitalists is the state of exuberance of the stock market, i.e. the
state of euphoria of the financial interests. If State expenditure can
sustain a near-full employment level of activity in the economy, then the
exuberance of the financial capitalists ceases to be a matter of much
concern. Governments can pursue whatever policies they consider socially
desirable without having to concern themselves with the impact of such
policy on the exuberance of the financial capitalists.
True, the maintenance of the economy at near-full employment may cause
accelerating inflation because of the exhaustion of the reserve army of
labour, but governments, under working class pressure, may become emboldened
to attempt to resolve such problems through even more radical measures, such
as prices and incomes policies, nationalizations, workers' management of
factories etc. Once the "state of confidence" of the capitalists is given
short shrift, then there is nothing to prevent the economy's ideological
"slide" to radical social engineering and even to socialism.
It is vital for finance capital therefore that the ideological weight of the
proposition that the "state of confidence" of the capitalists is crucial for
the well-being of society is not diminished one iota, for which the
proposition that State expenditure can boost employment with impunity must
be attacked, no matter how flawed in logic the attack may be.
This fact has a direct bearing upon the question of recovery from the
current world recession. The need for increasing government expenditure for
overcoming this recession is widely recognized. And it is also recognized
that it is better for recovery if this increase in government expenditure is
coordinated across the major countries rather than being sequentially
undertaken in an uncoordinated manner by individual countries.
But no such initiatives for recovery can be undertaken because of the
opposition of the financial interests to fiscal deficits. It is significant
that at the G-20 meeting in end-March there was no mention of any fiscal
stimulus, let alone of any coordinated fiscal stimulus. While in the
immediate aftermath of the financial crisis, in September and October, there
was much talk of a coordinated fiscal stimulus, that talk has died down now.
True, the United States and China have announced what appear at first sight
as sizeable fiscal stimulus packages. But the actual stimulus in the United
States, at least, as distinct from the increase in fiscal deficit caused by
the maintenance of government expenditure in the face of a decline in tax
revenue, is quite small. This is because much of the increase in federal
government expenditure announced by the Obama administration as part of its
stimulus package will merely offset the curtailment in government
expenditure in the various States of the U.S. on account of the decline in
their tax revenues.
By contrast, the "bail out" package to the financial system in the United
States is estimated to exceed $10 trillion. The strategy at present
therefore seems to be to sustain the financial system and wait for the next
"bubble" to appear rather than to revive the real economy directly through
fiscal stimuli. The consequence of this strategy will be a prolonged period
of recession and unemployment with much human suffering; but this only
underscores the power of the financial interests in contemporary capitalism,
where even a crisis of this magnitude engendered by their functioning leaves
this power undiminished.
Prabhat Patnaik is an economist at the Centre for Economic Studies and
Planning in the School of Social Sciences of Jawaharlal Nehru University in
New Delhi. This article was first published by the International
Development Economics Associates on 21 May 2009; it is reproduced here for
educational purposes.
URL: <http://mrzine.monthlyreview.org/patnaik240509.html>
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Received on Wed May 27 10:41:22 2009
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