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
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.  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
ECONOMIC CRISES. Historians have identified many types of economic crises in the early modern or preindustrial period: financial, general long-term crises, regional, the permanent crises of lower-class poverty, and short-term crises of famine or of famine combined with temporary unemployment. The financial crises, often set off by governmental bankruptcies, destroyed banking houses but rarely caused generalized distress unless they coincided with other troubles. The Spanish bankruptcy of 1559 ruined the Fuggers of Augsburg, and the bankruptcy of 1575 destroyed Genoese bankers, while the Spanish bankruptcies during the Thirty Years' War (1618–1648) amplified the economic dislocations that flowed from the war itself, the 1630 plague, and so on.
Historians once argued that preindustrial western Europe experienced at least two general economic crises, the first in the fourteenth and early fifteenth centuries in the era of the Black Death, and the second in the seventeenth century. These periods of economic dislocation, stagnation, and even contraction alternated, so it seemed, with eras of rapid and generalized demographic and economic growth in the thirteenth, the sixteenth, and the eighteenth centuries. Thomas Malthus, in An Essay on the Principle of Population (1798), expressed a common view when he stated that population tended to outstrip the available food supply and was brought back into balance only by war, famine, and disease.
It now seems clear that rather than alternating between periods of growth and periods of crisis in the centuries from 1300 to 1800, the economy of western Europe as a whole experienced a self-reinforcing process of growth in agricultural and industrial production, in commerce, in transportation, in banking, and in capital accumulation. There were significant technological improvements in shipping and in textile production, cost savings through division of labor in all sectors of the economy, very significant growth in total agricultural production, and so forth. The results were certainly not uniformly distributed across all of Europe, nor even within individual countries. There were marked regional contrasts. The cities of the densely urbanized and economically advanced Netherlands imported grain from less economically advanced and diversified regions such as northern France, Prussia, and Poland. The cities of northern Italy imported grain from southern Italy, Sicily, and North Africa. Wine flowed to northern Europe from the Mediterranean, while grain and salted fish flowed to southern Europe from the Baltic and the North Sea. For centuries, England supplied the more advanced textile cities of the Netherlands with wool, just as Spain supplied the textile cities of northern Italy. But there were also very backward areas in virtually every region of Europe that had at most modest local trade. Peasant villages in much of the French Massif Central often lived in virtual economic isolation even in the eighteenth century.
International trade linked together not only areas with different agricultural capacities, but also areas with significant differences in technology, wages, labor productivity, and general levels of development. Changes in textile production and commercial leadership in international trade shifted quite suddenly and produced dramatic regional crises of economic dislocation and adjustment. The prosperous cities of Flanders that produced luxury textiles collapsed in the early fourteenth century. A more diversified textile industry developed farther east, near Antwerp. Antwerp and Brabant developed into a powerhouse of international trade and finance in the fifteenth and sixteenth centuries, but collapsed during the Dutch Revolt in the 1580s. Antwerp fell from the foremost city of trade and finance in northern Europe to a virtual ghost town overnight in 1585. Leadership passed to Amsterdam. Likewise, the implosion of the economy of the cities of northern Italy during the Thirty Years' War led to massive deindustrialization and even refeudalization. At the end of the seventeenth and the beginning of the eighteenth century, Amsterdam and the Dutch provinces lost ground to England. In every instance there were multiple causes for these economic crises: warfare, rigid guild restrictions, technological changes in textile production, wage differences, the costs of transportation, changes in the makeup of the market, and others. The collapse of areas that had long enjoyed prosperity ushered in times of painful change. It was these extremely difficult phases of regional economic adjustment that historians once mistook for generalized crises in the fourteenth and seventeenth centuries.
Whether a given country or region was at the forefront of economic performance, toward the bottom, or somewhere in between, all experienced to a greater or lesser degree the intractable problems of unemployment, underemployment, periodic famines, and food riots. Preindustrial Europe lived in a state of permanent economic crisis that was rooted in generalized and massive lower-class poverty. There was no necessary correlation in Europe in the centuries from 1300 to 1800 between increases and decreases in population, in agricultural production, and in employment opportunities at living wages. Although progressive and self-reinforcing trends stimulated economic growth and development, these progressive forces were not sufficient to guarantee all a comfortable existence.
Those who lived in preindustrial Europe were well aware that something was amiss, and not just in the times of major economic crisis. Population, food, and jobs never seemed to be in balance even when times were good. The cities of northern Italy, most notably Florence, Milan, Venice, and Genoa, took on the financially and administratively onerous task of public food supply in the full flush of prosperity between 1280 and 1340 because markets left to themselves did not provide sufficient food at affordable prices. Public municipal granaries with the full array of price controls, public purchase, and stocking of grain were permanent features of urban life in northern Italy between 1300 and 1800, in good times and in bad. Cologne, Strasbourg, Nuremberg, and Frankfurt am Main established their municipal granaries in the fifteenth century and maintained them thereafter. The municipalities of Castile expanded and consolidated their elaborate food supply systems in Spain's Golden Age, the sixteenth century. The kingdom of Prussia established its public granaries in the eighteenth century.
In the first half of the sixteenth century, municipal governments in Catholic and Protestant states, driven by fear, compassion, and the supreme necessity of maintaining order, aggressively organized charitable institutions to care for the poor and the hungry. In England, Queen Elizabeth regularized a national system of welfare at the end of the sixteenth and the beginning of the seventeenth century that made each parish responsible for its own poor and authorized a system of local taxes, the poor rates, to finance charity. In the wake of a particularly wrenching era of famine, disease, and unemployment that coincided with the Fronde (1648–1653), the monarchy in France established general hospitals to incarcerate the incorrigible poor. A little more than a century later, in the 1760s and 1770s, in far better economic times, the French monarchy established charity workshops for the able-bodied unemployed and poorhouses for the incorrigibles. Even a country as economically dynamic as England in the century before the industrial revolution, 1650–1750, still had at least a quarter of its total population mired in irremediable poverty.
To ensure public order, something had to be done to provide jobs and to secure food at affordable prices. The debates grew shrill, and governments became desperate. No matter what they did between 1300 and 1800, the problems would not go away. From the middle of the seventeenth century, mercantilist writers in England and cameralists in Germany encouraged governments to intervene in the economy with state-owned factories, subsidies, monopolies, and other mechanisms to increase national wealth and to provide work for the poor. Everywhere governments regulated the supply and the sale of basic grains and bread. After a century of experimenting with controls of all sorts to no avail, learned opinion swung in the opposite direction. From the mid-eighteenth century, the Physiocrats in France lashed out against mercantilist controls and coined the phrase "laissez faire." In the British Isles, Adam Smith launched a full-scale attack on mercantilism in his free-trade classic, Inquiry into the Nature and Causes of the Wealth of Nations (1776). But the experiment in free trade failed to solve the food supply problem, just as it failed to provide adequate jobs for the poor. Grain riots broke out all over Europe in the 1760s and 1770s. In 1788–1789, the collapse of the monarchy in France coincided with a famine and a general depression in employment in the textile industry. The French Revolution began with the most extensive wave of municipal bread riots and rural uprisings in French history. From the 1790s, most governments returned to food supply controls and employment schemes.
The most wrenching and volatile economic crises of the preindustrial period were famines, and especially the famines that occurred in the midst of commercial and industrial depressions. Famines came in the wake of bad weather that significantly reduced crops. They occurred at every level of population and agricultural development, in economically advanced as well as economically backward areas, in regions that regularly exported grain as well as in areas that regularly imported it. The crises of the 1340s, 1360s, and 1430s, as well as the crises of the 1590s, 1648–1652, the 1690s, the 1760s, and the 1770s revealed permanent, structural imbalances in preindustrial economies and societies, not just weaknesses in agriculture.
The fundamental problems were those of widespread poverty and economic underdevelopment, compounded by insufficiently advanced governments. Labor productivity among the semiskilled and unskilled workers was very low because of low levels of technology in the jobs the masses performed. Low labor productivity meant low wages. The numbers of landless, working poor increased dramatically between 1500 and 1800, and the sheer numbers of available workers depressed wages further. The entire preindustrial economy depended on the low-wage labor of the working poor. In good times, the working poor spent 60 percent or more of their incomes on basic foodstuffs, typically cheap bread, beans, peas, maize, buckwheat, and, increasingly, potatoes. Average or effective demand for these basic foodstuffs moved up and down with long-term trends in population and income but changed little in the short term. In the event of a significant crop failure, prices rose dramatically, less in the eighteenth century than earlier, thanks to improvements in administration and transportation, but still enough to make food unaffordable for the working poor. If the famine coincided with a downturn in the textile industry, additional millions had no income at all. Municipal governments did a better job than central governments in securing adequate supplies at affordable prices. Often rural areas were stripped of food supplies, and their inhabitants were left to riot and starve.
Governments did not understand fully the economic mechanisms at work. They addressed the immediate problems by attempting to secure adequate supplies at subsidized prices and by moving vigorously to restore order. More generally, they encouraged agricultural improvement and did what they could to promote employment and discourage idleness. The results were invariably disappointing.
The only way out was through generalized economic development. Across-the-board technological innovations raised labor productivity and eventually raised wages for the lower classes. With higher wages, the working poor improved their diet. The consequent changes in effective demand transformed agricultural production. Cheap breads grew to be less important in lower-class diets, and food expenditures bulked less large in budgets. Eventually, a significant shortfall in grain production caused only minor inconveniences. In short, the way out of famine and poverty was the industrial revolution.
See also Agriculture ; Banking and Credit ; Bankruptcy ; Charity and Poor Relief ; Commerce and Markets ; Food Riots ; Industrial Revolution ; Industry ; Poverty .
Cipolla, Carlo M., ed. The Fontana Economic History of Europe, vols. 1–3. Hassocks, U.K., 1976–.
De Vries, Jan. The Economy of Europe in an Age of Crisis, 1600–1750. Cambridge, U.K., and New York, 1976.
Hufton, Olwen. The Poor of Eighteenth-Century France: 1750–1789. Oxford, 1974.
James L. Goldsmith