by Utsa Patnaik
Running a current account deficit for facilitating a diffusion of capitalism and thereby satisfying the aspirations of the bourgeoisies in other emerging countries is a hallmark of the leader of the capitalist world. A deficit is the instrument through which the leader holds together the capitalist world and keeps the system of its international payments arrangement intact, by accommodating its rival powers. The U.S. deficit played this role.
With the heating up of the Vietnam War the U.S. fiscal deficit, and consequently its current account deficit, began to widen further, which created excess demand pressures, not just in the United States but in other capitalist countries as well, which had to run correspondingly wider current account surpluses.1 This meant a boost to the rate of inflation globally, that is, a further increase in the level of prices relative to post–direct tax wages in the advanced capitalist world. This increase proved to be the proverbial last straw on the camel’s back; the rate of inflation exceeded the threshold rate above which it is incorporated into wage demands. In consequence there was a worldwide money-wage explosion in 1968, which further pushed up the inflation rate. This was the first instance of the bursting forth of a contradiction that underlay the long boom but had until then remained dormant.
Sweezy and Magdoff, following a line of argumentation that goes back to Hyman Minsky and even earlier to Irving Fisher, argue that an increase in inflation is endemic to a situation of Keynesian demand management.2 The aim of demand management is to prolong the boom and to prevent a crisis that would cause substantial unemployment. However, the longer the boom lasts, the fragility of the economy, including financial fragility, which Minsky emphasized, keeps increasing, and hence the depth of the crisis that would follow the collapse of the boom also keeps increasing. Preventing a collapse of the boom therefore acquired greater and greater urgency over time, but it amounted, in effect, to continuing to support an increasingly fragile economy through state intervention.
Such support, needless to say, must also take the form of preventing a drop in the inflation rate, for any such drop would push the economy toward a debt deflation of the sort that Irving Fisher had discussed, which would have serious recessionary consequences. So, the only direction in which the inflation rate can move realistically, in a capitalist economy where state intervention is supposed to maintain a high level of employment, is upward. (Steady inflation is at best an exceptional case.)
Whether an increase in the inflation rate was inevitable in an economy where the state was committed to propping up the level of activity despite growing financial fragility, which Sweezy and Magdoff suggested, or whether it arose because growing military expenditure, which necessarily leads to war, and eventually did actually precipitate one (in Vietnam), required even greater growth in such expenditure, is an issue that need not detain us here. On the basis of what we have suggested about a threshold level of inflation beyond which it becomes incorporated into the wage-bargain, even an erratic jump in inflation would push it beyond this threshold, precipitating accelerating inflation. The system, in short, was foredoomed to an inflationary crisis for any of these reasons.
Put differently, the concept of an “inflationary barrier” advanced by Joan Robinson cannot be identified with some particular level of unemployment. (Likewise, the idea of a unique “non-accelerating inflation rate of unemployment” is a chimera.) A given level of unemployment at which inflation has not been accelerating may suddenly witness accelerating inflation if there is an increase in workers’ consciousness and militancy. Indeed, whether inflation accelerates at a given rate of unemployment depends upon a host of factors, including the movements in the terms of trade, the past history of inflation, erratic jumps in aggregate demand, the learning process of the workers, and so on. The idea that a capitalist economy can be stabilized at a high rate of employment forever through state intervention in aggregate demand alone is false.
This became apparent in the advanced capitalist economies in the course of the long boom. The postwar dirigiste regime in the metropolitan world did experience an increase in the rate of inflation in the latter half of the 1960s. This caused a money-wage explosion, both as a response to it, and also for making up the loss in the share of the workers over the preceding period, which in turn led to a further acceleration in inflation. This was serious enough, but it also made the system unviable for another reason, to which we now turn.
The Collapse of the Bretton Woods System
The Bretton Woods system was based on a contradiction. The dollar was declared to be as “good as gold” and convertible into gold at $35 per ounce. Since the specificity of gold arises from the idea that it is never expected to, and never does, fall in value relative to the world of commodities in a secular sense, which is what gives meaning to the term “as good as gold,” the dollar being declared as good as gold required that its value should not fall in a secular sense vis-à-vis the world of commodities. If it ever did, then the dollar would cease to be “as good as gold,” in which case it would be impossible to maintain its convertibility into gold. In other words, the Bretton Woods system required for its viability that there should be no secular inflation in commodity prices in terms of the dollar. At the same time, it had no mechanism to ensure that there was no secular inflation in commodity prices in terms of the dollar. The contradiction in the Bretton Woods system consisted in institutionalizing something that it had no means of realizing.
The worldwide wage explosion in 1968 was thus the first blow to the Bretton Woods system. The creditors of the United States, who were sitting on a mountain of dollars that had accumulated ever since dollars started pouring out of the country as it became a current deficit country, now insisted on converting dollars into gold, which was not tenable. The gold-dollar link that had been the lynchpin of Bretton Woods was abandoned in 1971 and the system itself in 1973.
There is a misconception about the events leading to the collapse of the Bretton Woods system. Since President de Gaulle of France had taken a lead in demanding gold in lieu of dollars, the crisis of the system has often been attributed to de Gaulle’s bloody-mindedness arising from the American takeover of European firms through dollars printed back home. There was no doubt much angst in Europe at the time over the “American challenge,” and the Bretton Woods system that sanctified the dollar as being “as good as gold” was seen as an instrument of American hegemony. But the contradiction of the system was deeper and had structural roots: crucial elements of the colonial system that had worked to Britain’s advantage were not available to the United States. It lacked, to be more specific, any mechanism for keeping the inflation rate under control. And it is this lacuna that manifested itself in the late 1960s and early ’70s. It was not de Gaulle’s bloody-mindedness but the basic contradictions of the Bretton Woods system that led to its collapse.
Terms of Trade Movements
The collapse of the Bretton Woods system in 1973 suddenly left the world capitalist economy without a stable medium of holding wealth. The dollar (and dollar-denominated assets) had played this role earlier, but with currencies on a float and their respective values subject to great uncertainty, the world’s wealth-holders were suddenly left without any reliable medium for holding their wealth. There was a rush to holding commodities, which contributed to the sudden upsurge in primary commodity prices in 1973. No doubt an excess demand pressure was beginning to be felt, but the massive jump in the net barter terms of trade cannot be explained merely by “normal” excess demand without bringing in the panic shift to commodities that followed the collapse of Bretton Woods.
The net barter terms of trade between manufacturing and primary products that had moved against the primary commodities between 1950 and 1972 jumped by nearly 25 percent in their favor in 1973, and whether we include oil in primary commodities makes little difference to this movement. Soon enough, this rush to commodities subsided, even though there was a marginal increase, by about 9 percent, in the terms of trade of non-oil primary comm
odities between 1973 and 1974. In the case of oil, however, the story was completely different. The formation of OPEC and the decision to jack up oil prices by enforcing output cuts among members shifted the terms of trade between primary commodities including oil and manufactured goods by about 104 percent in favor of the former between 1973 and 1974.
The oil price hike was followed by a period of rapid inflation in the advanced countries. The inflation rate for the twenty-one OECD countries as a whole was 8.5 percent for 1973–80, and 8.8 and 8.6 percent for 1980 and 1981, respectively, compared to a mere 4 percent for the entire period of 1960 to 1973.
The inflation that continued in the late 1970s despite a reduction in the level of activity that occurred after 1973, which is often referred to as the “second slump” (the first being the slump of the 1930s), has been much discussed, with the term “stagflation” used to describe the phenomenon. But there is nothing remarkable about it. The inflationary upsurge was sustained by its own momentum, with inflation causing money wage demands, which then fed into inflation, and so on. This inflation was finally brought under control only with a change in economic regime, with dirigisme and the commitment to high levels of employment becoming things of the past, and a new regime of “neoliberalism” being introduced in the advanced countries with the triumph of Thatcherism in Britain and of Reaganomics in the United States.
There is a difference between the 1973–75 slump and what followed in the Reagan-Thatcher period. The 1973–75 slump occurred when the massive oil shock resulted in a shift in global income distribution from the bulk of the population in the advanced capitalist countries that were oil consumers to the OPEC countries, which held much of their enhanced incomes in the form of bank deposits with metropolitan banks. The “marginal propensity to consume” (to use a Keynesian term) by those from whom income distribution shifted was higher than the marginal propensity to consume of those in whose favor income distribution shifted. The oil price hike in short had a demand-depressing effect on the global economy.
To offset this effect what was needed was an increase in state expenditures at the global level. But since there was no coordination among capitalist states in this regard at the global level, since each state was making its own decision about how to cope with the oil shock and the resulting inflation, each took the decision to restrain or contract state expenditure in the wake of this shock. Individual capitalist states, instead of taking needed counter-recessionary measures, took measures on the contrary that either did nothing to offset the recession or actually compounded it.
The 1973–75 crisis can thus be seen as the consequence of the kneejerk reaction of the dirigiste regime to the upsurge of inflation. The paradigm still remained the Phillips Curve, only with the proviso that it had “shifted”; that is, the presumption was that after a certain time things would “settle down,” and there would once again be a revival of state intervention in demand management to achieve high levels of employment, perhaps not so high as had been experienced during the Golden Age, but sufficiently high nonetheless.
Some even thought of a “prices and incomes policy” with which countries could recapture the low levels of unemployment they had experienced during the “Golden Age” years. Such policies were tried for a while but without success. It was clear that a going back to the days of the postwar dirigiste regimes was no longer possible. An altogether new regime then began to emerge.
But capitalism is not a planned system; so the new regime did not emerge in a planned manner. It emerged as a consequence of the balance of class forces then existing. In particular, finance capital, which had been forced to make concessions after the war and had to willy-nilly accept the Keynesian demand management it had opposed in the prewar period, now asserted its will, both because Keynesianism was discredited by the inflation and also because finance capital had become greatly strengthened during the Golden Age years. It had become “international,” precisely what Keynes had not wanted it to be, anticipating rightly that such internationalization would undermine the autonomy of the nation-state to pursue demand management policies, though he did entertain the hope that the opposition of finance to state intervention in demand management would disappear when the correct theory was presented to it, since he attributed such opposition to a basic misconception. International finance capital backed the Reagan-Thatcher agenda, and the outcome was the end of the dirigiste regimes. Let us turn now to a discussion of the process of “internationalization” or “globalization” of finance.
The Process of Globalization of Finance
The end of the colonial arrangement meant that the leading capitalist country, which in an earlier epoch had offset its current deficit with rival powers through a drain from the colonies, now had to increase its debt. In the case of the new leader, the United States, debt took the form of exporting dollars. And as the U.S. current balance, which was positive to start with (otherwise the United States could not have become the world capitalist leader) became negative, the deficit started widening, with the ratio of dollar deposits in metropolitan banks (toward which the exported dollars gravitated) to the GDP in the metropolis increasing. And with it, there was increased pressure to open the entire world to unrestricted financial flows in search of profitable investment opportunities, which the Bretton Woods system had allowed countries to put up barriers against.
This pressure in a sense had to succeed. Since under Bretton Woods the surplus countries had been under no obligation to undertake any adjustments, which had to be carried out exclusively by the current-deficit countries, the latter, before undertaking the journey of deflation-cum-currency devaluation, were keen to have at least some short-term financing to give them some breathing space. The increased liquidity in the international financial markets caused by the large-scale dollar outflows from the United States, which had been the progenitor of the Eurodollar market, made it possible for the deficit countries to arrange short-term funding through “hot money” flows to meet immediate balance of payments difficulties. Britain, which was in balance of payments difficulties toward the end of the 1960s, was a major recipient of such flows.
The process of globalization of finance can be said to have begun with such flows. Once the flows started, governments had to be careful not to upset the “confidence of the investors,” a euphemism for speculators’ confidence, for then the balance of payments could suddenly plunge into a crisis. And since such “confidence” required keeping the economy open to financial flows, economies increasingly became open to such flows, moving away from the capital controls that the Bretton Woods system had allowed them to institute. This happened in Europe toward the end of the’60s, in Africa and Latin America, where IMF “conditionalities” were used for such “opening up,” in the ’80s, and in India in the ’90s. Whether the currency acquired full convertibility, which in many of these third world countries it did not, the economy got caught in the vortex of globalized financial flows.
When the oil shocks happened in 1973 and 1980, there was a further swelling of dollar deposits with the metropolitan banks, and several countries, especially in the third world, got saddled with balance of payments problems. The metropolitan banks were involved in the recycling of petrodollars, but they needed an agency to act as a monitor for them and the IMF took on this role. It not only acted as a conduit for such recycling through its own “Oil Facility” and “Extended Facility” loans, but it also facilitated borrowing by third world countries once they had accepted the “discipline” of IMF “conditionalities.” All this meant a change in the role of the IMF, from merely being an occasional lender to countries undergoing balance of payments stress and advising them to undertake “stabilization,” to becoming an instrument of international finance capital to get countries to undertake “structural adjustment,” which would open them up to unrestricted global flows in goods, services, and capital, including above all finance. It was ironic that an institution with whose founding John Maynard Keynes had been associ
ated in his capacity as a founder of the Bretton Woods system, who had wanted to “let finance be national,” now became an instrument for opening up economies to “reforms” so that finance ceased to be national.
Opening economies to global financial flows entailed a change in the relative weights of the nation-state and the-now globalized finance capital. To prevent finance from flowing out en masse, the state had to be careful not to upset the “confidence of the investors,” which meant kowtowing to the demands of finance. Finance, in turn, which had had to yield ground in the immediate postwar years because of the socialist threat and working-class restiveness in the advanced countries, was now in a position to establish its supreme hegemony, of which the adoption of neoliberal policies was an obvious manifestation.
This hegemony, and the associated neoliberal policies did not suddenly appear fully formed on one fine day. The crisis of the dirigiste regime caused by inflation, against which it had no bulwark in the post-colonial era, was exploited by international or globalized finance capital, which was in the process of being formed within the Bretton Woods system to launch an attack against this regime and replace it with the neoliberal regime, whose characteristics and implications we will examine in the next chapter. But before proceeding further we must distinguish between the account of the transition from dirigisme to neoliberalism that we have given above and accounts given by others. In particular, we shall take up certain comments by Paul Krugman for underscoring the sui generis nature of our analysis.
The Pitfalls of a Ricardian Reading of the Transition
Paul Krugman, of course, is not concerned with the transition between regimes. His concern is with the phenomenon of inflation, why it occurred in the late ’60s and early ’70s, and why it subsided subsequently, and he has provided a Ricardian interpretation.3 While we have emphasized the vulnerability of metropolitan capitalism because the colonial prop was no longer available to it, and while its market-providing role was taken over by the state that now carried out “demand management,” its inflation-restraining role could no longer be fulfilled, so that it was only a matter of time before the system would run aground, Krugman takes an altogether different track, which is essentially Ricardian in nature.
