Economic Crises

BIBLIOGRAPHY

An economic crisis is typically defined as “a turning point for the worst.” It refers to a period when “good times” turn quickly into “bad times,” when economic agents panic, leading to economic dislocation. The dislocation is the crisis—for instance, from the upper turning point of the business cycle to its immediate aftermath, until people’s expectations improve.

The history of crisis theory has a long and distinguished pedigree, ranging from Marxist economics, business-cycle analysis, and social and political analysis (Clarke 1994). There are various types of economic crises, ranging from cyclical crises to structural crises of the long wave and financial crises. These crises are interrelated with other types of crises, such as legitimization crises and, indeed, personal crises.

This entry will begin by discussing economic crises associated with business cycles. Cycles undergo upswing when economic growth, investment, and consumption are growing at respectable rates. Such cycles take various forms, as Joseph Schumpeter (1883-1950) pointed out, but if we take the typical eight-to-eleven year (Juglar) cycle as an example, factors start to negatively impact on growth as the upswing slows down. These factors variously include speculative bubbles, which eventually bust; higher costs of production, such as real wages, materials and oil, interest rates, and rent; and inadequate demand impinging on the process.

These myriad factors reduce the rate of profit before the upper turning point of the cycle. Eventually, this declining profit rate impacts on investment as businesses realize that underlying profitability has declined, and they react by reducing the rate of accumulation. Consumers, in turn, usually reduce the rate of consumption expenditure. This decline in demand then transmits into an economic crisis at the upper turning point of the cycle, leading to declining confidence, a deteriorating business environment, lower consumer confidence, and a degree of overreaction in the markets. This overreaction is a critical element of the crisis, as people often panic, selling their stock and reducing business activity. Such overreaction occurred, for instance, in the early phases of the (Juglar) recessions of 1974 to 1975, 1982 to 1983, 1990 to 1993 (1997 to 1998 in Asia), and 2000 to 2002 throughout much of the world.

Typically, the economic crisis also leads to or is associated with a financial crisis (especially during long-wave downswings). Martin Wolfson (1994) has shown that during the early phases of recession, the (U.S.) economy undergoes a financial crisis as the declining profitability, confidence, and animal spirits lead to a massive devaluation of capital and banking assets, causing consumers and businesses to withdraw such assets from financial institutions (and sell them off) and effectively engaging in a run on the banking and financial systems. Financial crises tend to moderate as lender-of-last-resort facilities are utilized to rescue the system from negative chains of bankruptcy, as Hyman Minsky (1919-1996) recognized. The crisis thus encompasses the early months of a recession, including financial crisis.

Crises are usually reserved for the most protracted periods of uncertainty, instability, and panic. Some analysts may extend the short-cycle crisis to the remaining months or years of recession, but this view may be problematic because, after a while, expectations tend to improve, leading to a recovery in the cycle. Slowly, investment and consumption demand pick up as bubble crashes moderate along with costs of production and perceptions.

Karl Marx (1861-1863) differentiated between the potential for crises and the necessity of crises. The potential for crises emanates from money and credit, which enable buying and selling to be separated, leading to realization problems. The goods may be “exchanged” before the payment of “money,” due to the existence of trade credit, promissory notes, IOUs, credit cards, and so forth. The market enables potential circulation crises to emerge through supply-demand coordination failures as the final payment of money fails to materialize due to insufficient demand and over-indebtedness.

The necessity for crises, according to Marx, lay in “the very nature of capital.” The clash between competition and monopoly, for instance, leads to innovation, which starts rounds of productive investment, imitation, and gradually excess competition and low profits, leading to crisis. The conflict between capital and labor during cycle upswings may variously lead to a diminished reserve army of labor, high wages, and low productivity, and thus low profits and economic crisis. The conflict between industry and finance will periodically lead to speculative bubbles rising and crashing, and thus to economic crisis. Marx saw these contradictions of capitalism as necessarily leading to crises, which may perform the useful functions of flushing out unproductive capitals and providing the basis for renewed accumulation after a period of crisis (Mattick 1981), except in the severest types of crisis.

The possibility of severe crises is associated with problems of: (1) debt deflation, (2) insufficient demand, and (3) structural crises of capitalism. Debt deflation, according to Irving Fisher (1867–1947), is endogenously generated through a series of interrelated processes. Innovation that is financed largely by debt in an environment of endogenous money often leads to speculative excess and euphoria, resulting in the liquidation of debt, greater uncertainty, declining velocity of money, falling prices, depression, and disarray. The psychology of business is important to this process; debt deflation occurred, for instance, during crises and panics in the United States in 1837, 1873, 1893, and circa 1929, in Japan from 1990 to 2003, and so forth. Fisher saw debt deflation as counter to laissez-faire and caused by the paradox of “over-indebtedness [being] so great as to depress prices faster than liquidation, [while] the mass effort to get out of debt sinks us more deeply into debt” (Fisher 1933, p. 350). He saw policy efforts toward reflation, consistent with the New Deal in the United States, as being potentially able to tackle such problems.

This is linked to the crisis theories of John Maynard Keynes (1883–1946) and Michal Kalecki (1899–1970), both of whom saw deficiency of demand as the principal momentum underlying the trend toward economic crises. For Keynes (1936), capitalism is inherently unstable because uncertainty emanates from investment in capital assets with a prospective yield linked to future prospects, knowledge of which is close to zero. In such an environment, investment is usually determined by the prevailing business climate, which generates waves of upward and downward accumulation through history. These cycles and waves of investment variously generate overproduction as the euphoria of upswing expands prospective yield (minus supply price) beyond fundamentals, with downswings manifesting in insufficient aggregate demand linked to stock market crashes, deep recessions, and depressions. Such instability leads to periods of moderate economic crises during the short cycles and more intense crises during the longer-wave downswings.

Kalecki (1971) was able to demonstrate technically how insufficient demand generates such crises from the investment-consumption dynamics of capitalism. For instance, in a simple model, “capitals get what they spend” and “workers spend what they get.” Profit, the critical variable affecting growth, depends upon the propensity to invest, which is affected by uncertainty. Uncertainty, however, is endemic in the system as a result of deep capital projects and speculative tendencies. The severity of crises, therefore, ultimately depends upon the intensity of this uncertainty, and the extent to which overproduction leads eventually to insufficient aggregate demand and instability.

Structural crises, the deepest and most prolonged form of crisis, are linked to long waves of development and relative demise (O’Hara 2006). Long-wave upswing typically occurs when institutions and technology are developed, leading to twenty or thirty years of higher than average growth without major financial crises or deep recessions. This approximates the era of the bourgeois revolutions in France and the United States; the Industrial Revolution of the late 1700s and early 1800s; the American and Australian gold rushes along with the “age of capital” of the 1850s to early 1870s; the period of industrial consolidation and business expansion of the late 1890s to 1910s; the postwar boom of the 1950s to early 1970s (O’Connor 1984); and possibly the age of the Internet, biotechnology, and sustainable energy during the second and third decades (at least) of the twenty-first century.

However, as institutions undergo demise and technologies mature, long-wave downswings occur for twenty or thirty years. These are the structural crises of capitalism, when profit rates, growth, investment, and (usually) standards of living for the masses have stalled. Hence the long periods when cyclical recessions and financial crises are deeper than usual: 1820 to 1850, 1875 to 1895, 1920 to 1945, and 1973 to the early 2000s. These structural, accumulation crises are long periods of above-average uncertainty, when the business outlook is generally negative (although short-cycle booms can be quite buoyant before the periodic crash). They also tend to lead to legitimization problems for many vested interests, including governments, businesses, institutions, and individuals. Personal crises tend to escalate during these times, along with social dislocation. Lender-of-last-resort facilities and big productive governments are quite likely needed to moderate such crises through raising the floor of cycles and reducing instability.

There is room for a better understanding of economic crises. More studies are needed to comprehend the early stages of recession; the linkages between economic and financial crises; and the relationship between business-cycle crises, debt deflation, insufficient demand, and structural crises of capitalism. There is also a need for further research on ways of moderating these crises and how the crises themselves may (in certain circumstances) be useful to clear the way for change and development.

SEE ALSO Bubbles; Business Cycles, Empirical Literature; Capitalism; Depression, Economic; Economics, Keynesian; Economics, Post Keynesian; Financial Instability Hypothesis; Great Depression; Long Waves; Marx, Karl; Panics; Recession; Schumpeter, Joseph Alois; Underconsumption; Wage and Price Controls

BIBLIOGRAPHY

Clarke, Simon. 1994. Marx’s Theory of Crisis. New York: St. Martin’s Press.

Fisher, Irving. 1933. The Debt Deflation Theory of Great Depressions. Econometrica 1 (4): 337–357.

Kalecki, Michal. 1971. Selected Essays on the Dynamics of the Capitalist Economy 1933–1970. Cambridge, U.K.: Cambridge University Press.

Keynes, John Maynard. 1936. The General Theory of Employment, Interest, and Money. London: Macmillan.

Marx, Karl. 1861–1863. Ricardo’s Theory of Accumulation and a Critique of It (The Very Nature of Capital Leads to Crises). In Theories of Surplus Value, Vol. 2, 470–546. Moscow: Progress Publishers.

Mattick, Paul. 1981. Economic Crisis and Crisis Theory. Trans. Paul Mattick Jr. London: Merlin.

Minsky, Hyman. 1995. Longer Waves in Financial Relations: Financial Factors in the More Severe Depressions II. Journal of Economic Issues 29 (1): 83–96.

O’Connor, James. 1984. Accumulation Crisis. London: Blackwell.

O’Hara, Phillip Anthony. 2006. Growth and Development in the Global Political Economy: Social Structures of Accumulation and Modes of Regulation. London and New York: Routledge.

Schumpeter, Joseph. [1939] 1982. Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process. 2 vols. Philadelphia: Porcupine.

Wolfson, Martin H. 1994. Financial Crises: Understanding the Postwar U.S. Experience. 2nd ed. Armonk, NY: Sharpe.

Phillip Anthony O’Hara