It is now widely acknowledged that the meltdown that started in the United States in 2007 and soon spread to many other parts of the world was the result of a gigantic misadventure in the financial sphere that artificially propped up a real estate boom. But how did these things come about? Rohit’s attempt in this volume is to provide a theoretically nuanced and carefully documented analysis of the phenomenon by going back into the manner in which the U.S. economy has performed since the Great Depression of the 1930s to which the latest crisis has often been compared.
It is an attempt to demonstrate the manner in which the ‘real’ economy of production of goods and services interact with the realm of finance. Thus consumers and investors, the market, the state and its agencies are all brought into the picture. It is a rare study by an Indian economist of the performance of the economy of the United States of the immediate past.
While the economy of the United States is frequently depicted as an example of the ‘free enterprise’ system, even a casual review of its development of the recent past will show the strategic role played by the state in the economic sphere. No one will challenge the fact that the recovery from the Great Depression was induced by the state through a phenomenal public works programme sponsored by the Roosevelt administration whose theoretical justification was (almost post facto) supplied by what has come to be known as the Keynesian economics. Of course, the recovery from the depression was also helped by the preparations for the Second World War and the stimulus that the War provided to the U.S. economy. The immediate post-War years also saw the active participation of the state in the economy, especially to establish American domination of the post-War ‘free world’ which provided opportunities for American private enterprise to grow.
The economic competition between the ‘free world’ and the Soviet Block during the immediate post-War period resulted in a spurt of innovations that stimulated investment and resulted in rapid economic growth. The decades of the 1950s and the 1960s have come to be known as the ‘Golden Age’ of the U.S. economy and, indeed, of capitalism itself. The decade of the 1970s was one of turbulence which saw America coming off the gold standard and some other global developments. However, the good performance of the two preceding decades led to the revival of the free market ideology (recall the days of “Reagonomics”) and to considerable deregulation of the financial sector. Rohit points out two major consequences of these changes, both in the corporate sector. The first was a series of mergers and acquisitions in the corporate sector that led to unprecedented business consolidation. Closely related was removal of restrictions on compensation for top level executives. In the economy as a whole these led to concentration of economic power and increasing inequality in incomes and wealth. There was a systematic busting of labour unions.
One would normally expect such a situation to lead to a fall in consumption and to economic stagnation. But as the next two decades showed, what happened was almost the opposite. One of the main contributions of the book is an empirical examination of this phenomenon and a convincing explanation for it. From 1950 till the early 1980 the share of consumption in the U.S. economy seemed to remain fairly steady at about 62 per cent of GDP notwithstanding periodic ups and downs. But from 1980 “the increase in the share of consumption has been dramatic”, fairly steadily moving up to almost 70 per cent at the beginning of the 21 century. And while the growth rate was low in the 1980s, it picked up in the 1990s making it a ‘fabulous decade’ culminating in the ‘Dotcom boom’. The explanation provided is that apart from consumption based on income, in the 1990s there was also consumption out of profits and capital gains and consumption facilitated by debt — “buy now and pay later” — which is what finance was actively engaged in.
The Dotcom boom, as the name suggests was closely related to the unprecedented technological progress in the information and communication industry of the late 1980s and the 1990s. But it was also closely related to the mergers and acquisitions that preceded it and the dominant role that finance had come to play in the U.S. economy from the early 1980s with the support of public authorities. This can be seen from what happened to WorldCom which was an insignificant player in the telecommunications industry during its inception, but between 1991 and 1997 it completed 65 acquisitions by spending $60 billion, most of which was financed through debt. This was interpreted as a ‘rags to riches’ story that finance could facilitate and there was a sharp increase in WorldCom’s stock prices. More acquisitions followed. Accounting malpractices were indulged in to show that profit shares were increasing. Executive compensations started soaring. Soon the malpractices could not be hidden; and WorldCom filed for bankruptcy.
Finance then moved to other spheres and the manner in which it stimulated and sustained the real estate boom of the early years of the present century and the collapse that came subsequently are now well known. The basic problem is that the growth of the economy under such circumstances is dependent on capital gains in various asset markets which are notoriously capricious and vulnerable — a warning to other parts of the world into which finance capital is now speedily flowing to stimulate ‘growth’ of a sort.
(C.T. Kurien is an economist and former Director of the Madras Institute of Development Studies)