Not a regulatory failure; rather a structural crisis

Carlos Arze Vargas

The fact that one of the risks inherent to the capitalist system – the over-production of capital derived from attempts to counteract the fall of profit rates by means of an increase of the reserve rates – has come to pass is evidence of the structural nature of the current economic crisis. This not only disproves the theory that a lack of state regulation of financial capital brought about the crisis but also calls for responses beyond those applied to date: essentially, increasing public debt in order to buttress corporate balance sheets.

Most of the many interpretations which have been put forward regarding the current international crisis refer to a financial crisis resulting from the lack of state regulation and appropriate practices on the part of financial institutions, while at the same time avoiding any reference to the structural problems of the system itself. On the basis of this diagnosis, the proposed solutions look to the state to save the banks and private industry and, at most, finance consumption through increased public spending. In effect, a resurrection of old and previously scorned Keynesian fiscal policy.

Some additional considerations

The risk of a crisis is inherent in any economy in which production is aimed not at satisfying essential needs, but at obtaining profits. This speculative function makes it possible for a producer to decide not to sell—or even not to produce – if profits are insufficient.

Crises in capitalism are over-production crises. This danger arises from the producer’s need to accumulate an ever-increasing amount of capital, saving some of the profit (capital gain) in order to gain a share of the market. As the selling price – in which supply and demand play their part – includes the average profit of all the sector’s producers, every capitalist will attempt to accumulate capital by utilizing the technical factors that will increase productivity above the current average. That is, increase the capital ratio constituted by the means of production, to the detriment of the fraction devoted to paying the labour force (which generates capital gains).

Paradoxically, the constant mechanization and modernization of the stock of capital will produce the opposite effect: the gradual fall of the capital gain obtained through the exploitation of workers, due to the proportionate fall of variable capital, which leads to the fall of the average rate of profit – to the extent that this merely constitutes an expression of the quantitative relation between capital gain and invested capital. In response, more will be produced in order to counteract the fall of the rate of profit with a greater mass of profit. The fulfilment of this process can generate a critical over-production of capital.

Over-production leads to the destruction of capital, not only through the disabling of the means of production, but also through the devaluation of shares. Surviving, more concentrated capital, can re-initiate production under renewed conditions, thanks to the destructive effect of the crisis on employment and salaries. The monetary system will also suffer insofar as the devaluation of capital will prevent payments and growing debt will unbalance the credit system.

Background to the current crisis

The capitalist rate of profit in the US has gone through high and low periods which alternated during the 1950s, but has never fallen below an average of 4 per cent. After the 1958 recession, profitability improved due to technological innovations and the relaxation of labour standards. Investment in technology caused the rate of profit to drop during the 1960s. Another period of depression began in 1973, which eventually affected all major economies and caused the international monetary system to break down. The inflationary policies adopted to overcome this situation led to the debt crisis of the 1980s.

The application of the neoliberal model in response to the new crisis amounted to an anti-Keynesian counter-revolution; it toppled the barriers to capital one by one and caused the so-called welfare state to crumble. The broadening of the scope of capitalism enabled the ostensible recovery of the profitability of capital until the US entered a recession in 1991, when the forces promoting growth gave out.

The way out of this new recession and the subsequent rise of the US economy were the availability of capital (following the Cold War), the depreciation of the dollar (from the mid-1980s), which made the country’s products more competitive, the stability of oil prices and, most importantly, the increase in the exploitation of the labour force thanks to the relaxation of labour standards. High-cost technologies increased productivity and stopped the fall in the rate of profit. Thus, as investment increased, so the rate of profit of non-financial enterprises rose steadily from 1992 to 1997. Accumulated profit also rose, due too to the fall in the rates of interest which enterprises had to pay.1

High profit expectations gave rise to the explosive growth of stock market indices, mainly the NASDAQ index from the mid-1990s onwards. In the face of the perception that income would continue to grow sustainedly in the “new economy”, enterprises went increasingly into debt. In addition, the increase of asset values, together with rate of exchange conditions, gave rise to an increased inflow of foreign capital to buy State bonds and the financial assets of enterprises. In consequence, the dollar appreciated and the price of those assets increased. This process is known as the Information and Communication Technology (ICT) bubble, which burst in the early 2000s.
When all of this frenzied activity came to a stop, the excess of investment, or over-production of capital, gave way to recession: the over-production of use value which did not translate into the profitability expected led gradually to the fall of production and the growth of idle capacity in several productive sectors.2

High over-accumulation, together with the subsequent drop in profitability and accumulated profits, devalued assets when it became evident that profit expectations were unrealistic. This led to a lack of liquidity and credit and increased rates of interest. During the 2001 recession the United States Federal Reserve, which had begun to reduce its interest rates, accelerated this process towards the end of the year 3 and the federal government increased defence expenditure substantially, under the shelter of the political effects of the September 11 attacks, which revived demand. These expansive policies made it possible to halt the devaluation of assets and even to increase their price again, a fact reflected in the recovery of the stock exchange in 2003.4

This was possible due to the exceptional US capacity to go into debt, owing to its position as principal monetary centre as well as to countries that promote competitiveness by keeping their currencies artificially depreciated through the purchase of US debt – as is the case in China, in particular. This led to the even greater growth of the US fiscal deficit, which reached 6 per cent of GDP, close to USD 250 billion in 2005, rising from USD 100 billion in 2001.

The depreciation of the dollar, which cushioned the drop in stock exchange assets, also increased the price of real estate, thanks to the flow of new credit towards that sector and the promotion of new means to refinance mortgages.5 Both the state and private capital were attempting to maintain consumption on the basis of people’s capacity for debt – which greatly surpassed their real capacity to pay and the value of the assets themselves. This is the situation in which the explosive increase of high-risk or ‘subprime’ mortgages took place, leading to the crisis of US financial institutions, when thousands of borrowers were made insolvent,6 even dragging down workers’ pension funds.
The real rate of interest rose from 1% in 2004 to 4% in 2005, badly hurting borrowers who had been encouraged to go into debt by low interest rates and the belief that housing prices would continue to rise. Masses of fictitious capital had been generated, based on the artificially elevated value of stock exchange assets, divorced from the only source of new value – the exploitation of the labour force in productive activities.7

The global framework

All of this took place in the context of a world economy that had changed greatly owing to the impact of previous crises and by the repeated defeat of the working classes in the face of capital, throughout the 1980s. The fall of socialist regimes – particularly the former Soviet Union – gave new vigour to a crisis-bound capitalism, reflected in the largely unchallenged adoption of neo-liberal policies in most of the world.

Within this new world context, China emerged with its gradual but steadily opening market (see box: The Chinese Box). The enormous emerging market potential and the over-accumulation of capital in the major powers generated an increasing flow of investment to China, taking advantage of the deregulation and relaxation of labour standards and the low cost of labour in order to increase the rate of profit, which had been greatly reduced during the previous stage.

However, just as over-accumulation in the metropolis encouraged the inflow of large amounts of capital in China, a crisis such as the current one, which reduces the demand for Chinese products by the developed world, generates over-accumulation in China itself, with unexpected consequences for the world economy. To the relationship of dependency on the US,  demand from which capital gain in China depends, must be added the fact that China has become the major US creditor, financing part of the US deficit created to activate demand. 
Destruction as a way out

For all of these reasons it is possible to conclude that we are in the midst of a structural crisis explained by a long-term downward trend of the rate of profit which has undermined the valuation of capital. However, such a fall, which is common in industrial cycles, in this case cannot be reversed through the increased exploitation of the labour force – as was attempted in China – nor through the recomposition of capital, due to the high over-accumulation of capital. In other words, unlike in 20th century crises, this time the crisis must be ended by the destruction and ‘cleansing’ of capital/stock, in order to give rise to the recovery of the rate of profit.

The very nature of this structural crisis has made it general, not only because it encompasses several essential countries and sectors – and its evolution could lead to a profound worldwide depression – but also because it obeys the tendencies of contemporary capitalism itself, mainly with regard to its speculative aspect, strengthened by the current capacity of capital to transcend national boundaries.

Due to its severity, the crisis will make the exploitation of the labour force even more serious. All crises lead to a deterioration of labour conditions as capitalists adopt new ways to maintain their place in the market, interrupting production first and destroying capital later. The situation becomes even more violent in the initial stages of recovery when entrepreneurs take advantage of unemployment and the extraordinary profits provided by the concentration of surviving capital.

With such an outlook, clearly the solutions adopted by international organizations and the Governments of industrialized countries aim at preventing a radical way out through the destruction of capital, artificially supporting the balance sheets of enterprises at the cost of increasing the States’ deficit or responsibilities, which sooner or later will be transferred to the workers. Similarly, expansive fiscal policies attempt to maintain levels of consumption which favour the return of investment, whilst recommendations regarding the reform of financial regulation are accompanied by others which are aimed at intensifying the flexibility of the labour market. However, there are no significant measures – beyond the ILO call for a global jobs pact – to lessen social effects and the increase of poverty among the working classes. In short, measures are aimed at attempting the repetition of policies which, in the past, had no other effect than postponing the collapse of the system at the cost of accumulating powerful tendencies which are bringing society ever closer to barbarism.


BOX : The Chinese Box8

Due to its gradual and organized transition to capitalism, China is a special case, although in the end, not radically different from the USSR and Eastern Europe. In the late 1970s, the government of Deng Xiaoping initiated a number of reforms, including the following:

  • In agriculture, individual appropriation of part of production – in excess of allocated quotas – was allowed and the transfer of the use of land, in the absence of private property, was recognized.  The goal was to increase production and competitiveness by means of gradual changes to property rights, beginning by granting limited rights over the use of surpluses, followed by the distribution of profits and leading to the sale of small and medium enterprises to both executives and workers and the sale of packages of shares in large corporations to foreigners.
  • A gradual liberalization of foreign trade was initiated, which encouraged both external and internal competition. Import tariffs and para-tariffs were reduced and export tariff exemptions were implemented. Along with broader export rights for local enterprises, restrictions regarding exportable products began to be eliminated, with exceptions for minerals and textiles, already subject to quantitative quotas due to the effects of international agreements on access to external markets. However, the most notable measure to encourage exports appears to be the 300 per cent devaluation of the yuan  between 1981 and 1995.
  • Prices were freed in the mid 1990s.
  • New state banks were established devoted to financial intermediation and foreign trade, although the function of supplying state companies with highly-subsidized credit continues to be a priority of the national banking system. The presence of foreign banks is minimal, due to restrictions in their operations.
  • China has encouraged foreign investment by means of the creation of five zones of attraction in the country, with infrastructure, special laws and preferential taxation. Although foreign enterprises have restricted access to the internal market, they are able to take advantage of lower production costs, mainly regarding labour,9 and can obtain incentives for their exports.


Ultimately, these reforms turned the Chinese economy into the most dynamic economy in the world. Over the last 25 years, the GDP has multiplied by 11, with an average annual rate in excess of 9%, its exports have multiplied by 100 and its currency reserves have gone from USD 160 million to USD 610 billion.10 The main cause of this spectacular performance was the exponential growth of foreign investment – mainly in the electronic and computer industry (20% and 12%) and mining (15%), according to 2002 data from the US Bureau of Commerce – from an annual average of USD 360 billion in the first five years of the reforms, plus an additional USD 50 billion in this decade.

Similarly, the participation of foreign capital stands out for its gross capital formation, which reached an average over the last decade of over 13 per cent. Investment represents 40 per cent of Chinese GDP, as compared to 18 per cent in the US, 25 per cent in Japan and 22 per cent in the European Union.11 These exceptional results would not be possible without the high unemployment and low labour standards resulting from the erasure of the achievements of China’s socialist past. This means that the economy would be in great difficulty if faced with a fall in external demand, which generates a much higher income than that in the internal market.

Some analysts believe that the process is very similar to that of the original accumulation of capital, led by an absolutist regime whose agenda includes the restoration of capitalism. However, this restoration is subject to the dynamics of monopolist international capital and not merely to the interests and objectives of the Chinese Communist Party. In fact, industrialized countries, faced with internal over-accumulation of capital, are attempting to conquer the vast Chinese market in order to take advantage of the low cost of labour and raw materials available in China and, therefore, revalue their capital.

The same reforms which turned China into a factory for the developed world also gave rise to enormous masses of unemployed, as a result of the liquidation of agricultural collectivism and the attraction of modern enclaves based on capital-intensive production in urban areas. In response, the Government has promoted subsidized public investment plans which are economically very inefficient. Despite these measures, a growth rate of 8 per cent has been unable to absorb a rate of unemployment which encompasses 9 million people.

The other aspect of this process, which includes the risk of over-production, is low internal consumption, due to the intensive nature of investment and extremely low salaries, which were useful in obtaining high levels of profitability but have now become their own insurmountable restriction.

1 Caputo and Radrigán in Acumulación, tasa de ganancia e inversión en los países desarrollados (“Accumulation, rate of profit and investment in developed countries”) maintain that interest payments by non-financial enterprises dropped from 60% to 22% and that profit taxes fell from 32% to under 29%. Ramos and Ryd note that in the first half of the 1990s the real interest rate dropped from 8% to 3%, then began to increase, reaching 6% in 2000. See Estados Unidos y China: Ciclos económicos y políticas en un capitalismo maduro y uno naciente (“USA and China: Economic cycles and policies in raising and mature capitalism”), Development Macroeconomics Series 4, ECLAC, Santiago de Chile, 2005.

2 Utilized capacity fell from 83% in 1997 to 69% in 2002 in the durable goods industry; from 87% in 1994 to 72% in 2001 in the automotive sector, and from 93% in 2000 to 58% in 2001 in the high technology sector.

3 This rate, which was 6% at the beginning of 2001, fell to 1.8% in December and to a historic 1.3% in 2004.

4 See Ramos and Ryd 2005. op cit.

5 According to Standard & Poor and the Federal Housing Agency, the US housing price index rose from 2001 to 2006 at an average rate of over 13%. It fell to about 9% in the final quarter of 2007 and to 8.2% in 2008.

6 According to Federal Reserve (2009) data, family mortgage debt rose from USD 55 billion in 2001, to USD 1.1 trillion in 2005, then fell steadily from 2006, reaching a negative figure of USD 109 billion in late 2008.

7 In extreme examples of speculation, billion-dollar frauds occurred, such as the USD 50 billion pyramid scheme by financier Bernie Madoff, recalling the 2001 Enron case, which caused losses estimated at USD 150 billion.

8 This sub-section is based on Claro, Sebastián, 25 años de reformas en China: 1978-2003 (“Twenty-five years of reform in China: 1978-2003”), FCEA-Pontificia Universidad Católica de Chile. Available at: <>.

9 According to Fung, Lau and Lee (U.S. Direct Investment in China, AEI Press, Washington, 2005), the average monthly salary in the region of Shanghai, where the highest salaries were paid, in 2000, was USD 186; whereas the average salary in Mexico was USD 800.
United States Department of Commerce, data for 2002.

10 Bustelo, Pablo. El auge de China: ¿amenaza o ascenso pacífico? (“The rise of China: threat or peaceful growth?”), Real Instituto Elcano, 2005.

11 See: García Martínez, Carlos. Economía China – Su prospectiva en los bloques del siglo XXI, (“The Chinese Economy – its future in the blocs of the 21st century”). Ed. Ciudad Argentina, Buenos Aires, 2005.