by Utsa Patnaik
The “unwillingness” of the United States likewise arose not only because it had no such extensive colonial possessions to give it a market “on tap” but also because the other possible source of external demand (“external” to the capitalist sector proper), namely state expenditure, could not be used. The “unwillingness” of the United States to play the leadership role of the capitalist world, in other words, really meant the U.S. state’s inability to overcome the opposition of U.S. finance capital to larger state intervention for generating aggregate demand.
The New Deal intervention we saw was brief for this reason. Once there was some recovery under the New Deal, fiscal “rectitude” was once again asserted, which brought the economy back to a recession in 1937. Just prior to the rearmament effort for the war, while the consumption goods sector in the United States was working at a reasonable rate of capacity utilization, the investment goods sector was still experiencing massive unutilized capacity.
What appears at first sight as the world capitalist system’s failure to make a transition from Britain to the United States as its leader turns out on closer inspection to be the system’s failure to make a transition from colonial markets as the external prop for its stability to state expenditure as the external prop. To be sure, associated with any change in the external prop is an entire change in the characteristics of the system, including on the question of who plays the leadership role. But simply focusing on the absence of a leader without recognizing that the problem really was the absence, as yet, of an external prop to take the place of the colonial prop, is misleading.
Finance Capital and State Intervention
U.S. finance capital, we suggested above, was opposed to U.S. state intervention for boosting aggregate demand. But it is not just U.S. finance capital; opposition to state intervention to boost aggregate demand is a common trait of finance capital, which is why when Keynes originally suggested “public works” financed by a fiscal deficit to alleviate unemployment in Britain in 1929, through a position articulated by Lloyd George, the leader of the Liberal Party to which he belonged, the British Treasury, under the influence of the City of London, had turned it down. And even after Keynes had written his General Theory, the opposition by British financial interests to his position contained in it continued. This is why his opus was less influential, including even in academic circles, in his own country than in the United States.
Why finance capital should be so systematically opposed to state intervention to enlarge aggregate demand remains an intriguing question. Before exploring it, however, we should clarify a preliminary point. Larger state expenditure that is financed through taxes on workers, though it would be acceptable to finance capital, would not obviously give rise to much net expansion in aggregate demand because the workers consume a substantial part of their incomes. This would amount, therefore, to a mere substitution of state demand for workers’ demand, with little net increase in aggregate demand. A net increase can come about if larger state expenditure is financed either through a tax on the rich (who have a high propensity to save) or through a fiscal deficit, which means not taxing anyone.
Now, a tax on the rich to finance larger state expenditure does not make them any worse off than before the government embarked on such a program. Let us consider concretely a tax on profits and let us assume for simplicity that all wages and half of post-tax profits are consumed and the shares of wages and profits in total income are half and half. Then a government expenditure of $100 financed by a tax on profits will raise income by $200: the wage bill by $100 and pretax profits by $100. But since this increase in pretax profits will be taxed away, post-tax profits and capitalists’ wealth will be left exactly where they had been. Employment and output would have increased without the capitalists, despite paying more taxes than before, being any worse off than before.
Even so, one can understand finance capital being opposed to larger taxes on the capitalists, and more generally upon the rich, despite their not being worse off through paying such larger taxes. But why should it be opposed to a larger fiscal deficit, which does not entail any larger tax payments by anyone and, on the contrary, increases capitalists’ post-tax profits and wealth? In the above example, $100 of additional government expenditure financed by a fiscal deficit will raise income by $400, and profits by $200. Capitalists’ consumption will rise by $100, and wealth (through larger savings held in the form of claims on the government) by $100. Why should finance capital be opposed to such spending financed by a larger fiscal deficit?
Keynes’s answer to this question, which would be echoed by many economists even today, was that finance capital was unaware of the actual implications of a fiscal deficit. Its opposition to fiscal deficits was based on a wrong understanding. In fact, the theory of the multiplier, developed in Keynes’s pupil Richard Kahn’s original article on the subject, was an early attempt, even prior to the publication of the General Theory, to eliminate the basic misunderstanding upon which the opposition of the “Treasury View” in 1929, to the proposal to finance a program of public works through a fiscal deficit, was based.7
The opposition to fiscal deficits was based on the argument that government borrowing “crowds out” private investment, because there is a fixed pool of savings in the economy (leaving aside foreign borrowings and lendings) from which, if the government takes more, less is left for private investment. In such a case, the increase in employment caused by public works would be offset by the decrease in employment caused by the reduction in private investment, so that there would be little net expansion of employment.
The fallacy in this argument arose from the fact that savings, far from constituting a “fixed pool,” depend upon income and would increase through an increase in income and employment. At any interest rate, therefore, a fiscal deficit would generate an exactly equal amount of excess private savings over private investment (in a closed economy) and thereby finance itself, through an expansion in income (and employment), without causing any crowding out. This proposition was just a corollary to investment (in a closed economy) generating an amount of savings exactly equal to itself at any interest rate, by causing a rise in income that is exactly such as to make this happen..
Keynes’s presumption, however, turned out to be wrong. The opposition of finance capital to fiscal deficits, even in the midst of crises where a fiscal deficit will raise not just income and employment but the magnitude of profits as well, continues unabated. This is evident in that all over the world, with the exception of the United States, governments have adopted “fiscal responsibility” legislation limiting the magnitude of the fiscal deficit to 3 percent of the GDP, which is reminiscent of the “balanced budgets” earlier. So, instead of correct theory overcoming the hostility of finance to fiscal deficits, this hostility has trumped correct theory by bringing back the pre-Keynesian concept of the “crowding out” effect.
Michal Kalecki was closer to the mark when he suggested that the opposition of finance to fiscal deficits, or more generally to any direct state intervention through fiscal means for increasing the level of activity in the economy, arises because such intervention undermines the social power of capital, and with it, in particular, of that segment of capital which consists of finance, controlled by “functionless investors,” to use Keynes’s phrase.8 It makes the level of activity in the economy independent of the “state of confidence” of the capitalists, and thereby strikes at the base of the social power of capital.
It opens the possibility for the question to be raised: If the state can directly increase investment, then why do we need capitalists? And once it does, then the next government may widen state intervention even further by encroaching on the domain of the capitalists. This fear of state intervention among the capitalists, however, does not arise under fascism because under fascism they have direct control over state power. Under fascism, as Kalecki put it, “there is no next government.”
The matter may be put in a somewhat differe
nt way. Consider a slave system. Within the system, it is obvious that the slaves’ interest lies in keeping the slave owner happy, for otherwise he is likely to whip the slaves. But if one looks at the system from “outside,” then it is equally obvious that the slaves’ interest lies in overthrowing the system. These two positions are what one may call positions of “epistemic interiority” and “epistemic exteriority.” For slavery as a system to continue, it is important that epistemic exteriority must be prevented, that is, there must be an “epistemic closure.” Indeed, all systems based on class antagonism require an epistemic closure in this sense for their survival and continuity, which includes capitalism as well.
Fiscal intervention by the government to raise employment directly breaks this “epistemic closure.” This is felt spontaneously by capitalists, including above all the financiers, which is why they oppose such intervention (and why they are less averse to government intervention through monetary policy, since it operates, after all, through capitalists’ investment decisions). Except in a period of great weakness of finance capital, when its hegemony is socially challenged and it is forced to make concessions, it strongly and successfully opposes direct state intervention in demand management, as it did in the 1930s.
Concluding Observations
The Great Depression was a period when world capitalism was between external props. The prop of the colonial arrangement had gone, which is not to say that colonialism had become obsolete, but rather that there was no new prop, such as what direct state intervention in demand management could provide.
Indeed, colonialism and state intervention in demand management are the only two possible external props that capitalism can use. Schumpeter attributes to Keynes’s The Economic Consequences of the Peace an understanding precisely of this kind (though of course neither Keynes nor Schumpeter mentioned colonialism), namely that the pre–First World War conditions under which capitalism had thrived had passed and that capitalism would now need a new basis for a boom, which could only be provided by the state. He then suggests that the intellectual agenda that was to be carried to completion in the General Theory had already been sketched out in The Economic Consequences of the Peace. Whether this reading of The Economic Consequences of the Peace is correct is beside the point; the fact of capitalism in the interwar period, having run out of props, without which it cannot grow, is undeniable.
That capitalism had run out of leaders, as Kindleberger suggests, was merely a manifestation of the more basic fact that it had run out of props. The Great Depression was so deep and prolonged because of this basic fact.
CHAPTER 13
Public Policy and the Great Famine in Bengal, 1943–44
As we have seen, the mechanism of the drain of wealth up to the Depression turned on Britain’s appropriating every year India’s entire global external earnings of gold and sterling from commodity export surplus, while using rupee budgetary revenues to recompense the producers for their net exports. The appropriation took place against regular administered invisible demands on India that were detailed both in sterling on India’s external account and in rupees in the budget under “expenditure abroad.” The total of these invisible demands, however, included non-recurring items as well, and thereby the total was always pitched higher than India’s external earnings over a run of years, no matter how fast the latter might grow, so that the current account was kept in deficit. As India’s external earnings declined sharply during the Depression, Britain’s invisible demands, far from declining, rose further as it sought to moderate its own crisis at the colonies’ expense. This produced exceptionally enlarged current account deficits for India from 1925–26 to 1938–39, and these forced substantial and unprecedented outflows of financial gold to Britain, in addition to India’s incurring fresh debt to finance them.
The war years saw enhanced levels of extracting resources from India, but through an entirely different mechanism, that of a “profit inflation,” whose theoretical and practical meanings we explore in this chapter. While it was taking India’s global foreign exchange earnings, which had always been the object over the entire period of colonial rule, two factors now produced an altered situation. First, these earnings had declined with no prospect of recovering to earlier heights in a changed world slowly recovering from the Depression. Second, with the outbreak of war, Allied troops and air personnel poured into Eastern India, and the immensely enhanced war expenditure required for their operations was now charged directly to the Indian budget against a promise of repayment after the war ended, whenever that might be. In effect, a forced loan was taken from India, which was declared a combatant nation without consulting its people. Its people were also not consulted over the decision to put the burden of the Allies’ war spending on the Indian budget.
There are several dimensions of this decision to make Indians bear the brunt of war financing that are not generally known. The first is the astonishing scale of financing in relation to the size of the normal budget—over the period 1939 to 1943, there was a nearly eight-fold expansion of budgetary expenditure. The second is the mechanism by which three-quarters of this expansion was effected, through deficit financing and monetizing the deficit, producing a much more rapid inflation than in other countries. The wholesale price index rose 70 percent in Britain over the war period, while it rose 300 percent in India as a whole, and to a greater extent in Eastern India. The great famine of 1943–44, in which three million civilians belonging to the poorest rural classes starved to death in Bengal, was a result of this exceptionally rapid food price inflation. The third is that these measures leading to rapid inflation were not accidental but quite deliberate, representing the policy of “profit inflation” for meeting the abnormal spending required in wartime, a policy that had been put forward at a theoretical level by John Maynard Keynes and was implemented in practice in India. The same policy of profit inflation had been proposed for Britain by Keynes, but it was not implemented, owing to strong opposition from the trade unions, and was substituted by enhanced progressive taxation. In view of his expertise on India, Keynes himself had been given special charge of Indian monetary affairs, in addition to his general advisory role, when he was appointed in 1940 as adviser (along with Lord Catto) to Britain’s Chancellor of the Exchequer.
Profit Inflation as a Means of Raising Resources
The policy of profit inflation was deliberately followed by the British and colonial governments with a specific purpose: to raise resources from the Indian population by curtailing mass consumption in order to finance the Allies’ war in Asia with Japan. Keynesian demand-management policies are usually associated with raising employment and incomes, but Keynes also discussed the exact opposite, measures for curtailing mass incomes. He considered these necessary to raise resources for financing wartime spending in both A Treatise on Money referring to the First World War, and in How to Pay for the War, regarding the Second World War.1
Keynes had been closely associated with Indian affairs from an early period of his life. He served for two years in the India Office in London, leaving it when twenty-five years of age, and used the experience he gained there to publish Indian Currency and Finance five years later.2 He gave evidence to, or was a member of, successive commissions set up to deliberate on Indian finance and currency: the Chamberlain, Babington-Smith, and Hilton Young commissions, and for a while the Indian Fiscal Commission. He wrote articles on India and reviewed books on the Indian economy for the Economic Journal, which he edited (such as T. Morison’s The Economic Transition in India that discussed the drain of wealth). Keynes also lectured at Cambridge for many years on Indian monetary affairs.
In 1940, in view of the unusual financial situation arising from war, the British government appointed two economic advisers to the Chancellor of the Exchequer, an ex-banker, Lord Catto, and J. M. Keynes, with Indian monetary matters specifically entrusted to Keynes given his expertise in the area. Keynes was the most influential figure at the Bretton Woods Confere
nce in 1944, where the repayment of sterling owed by Britain to India was discussed by him with the Indian delegation. Keynes’s four-decades-long India connection, his interest in the Indian monetary system, and his part in policies followed in India during the Second World War have been neglected by his biographers, who appear to have had little interest in, or understanding of, the financial and monetary mechanisms underpinning colonial rule that concerned Keynes.
The term “profit inflation” was coined by Keynes to describe a situation where output prices rise faster than money wages because of an excess of demand over inelastic supplies. Profit inflation redistributes incomes from wages to profits and ensures substantial reductions in the consumption of wage-earners. It can be applied equally to a situation, where in addition to wage-earners, a large part of the working population comprises self-employed petty producers like artisans, fisher folk, and small peasants who have to buy food staples from the market since they produce either no food at all or not enough to meet their needs.
Profit inflation was a deliberate policy adopted in India for war financing. Without a deliberate policy of curtailing mass consumption, over £1,600 million of extra resources could not have been extracted from Indians during the war, with the bulk of this burden falling on the population of Bengal since Allied forces were located in and operated from that province. The state policy was to redistribute incomes away from the mass of the working population, toward capitalists and companies, by inducing a rapid profit inflation. The colonial state directly spent, in every war year after 1941, a multiple of its normal revenues by printing money, an extreme measure of profit inflation.
In A Treatise on Money: The Applied Theory of Money, referring to the First World War, Keynes had written:
