Global Capitalism towards another Stagflationary Crisis

 Sunil Dharan1

On June 15, 2022, the Federal Reserve Bank of the United States increased its target interest rate by 75 basis points. This is the biggest hike since 1994. Earlier, in the first week of May, it had increased the benchmark rate by 50 basis points. Major central banks, around the world, have been doing the same. The Reserve Bank of India has also increased its benchmark rate in quick succession. The repo rate was hiked by 40 basis points on May 4 and 50 basis points on   June 8.

These interest rate hikes are in response to rapidly rising inflation in these countries. Prices and cost of living are increasing at a fast pace in large parts of the world. In the United States, the current inflation is the highest in four decades. Against the Fed’s targeted inflation rate of 2 per cent, in April, consumer prices had risen by 8.3 per cent compared to last year. Even when food and energy prices are not taken into account, the increase was 6.7 per cent.

Other western economies like the UK, Germany, Canada and Spain are also experiencing rapid increase in prices. In the Eurozone, the price level has gone up by 8.1 per cent and is likely to go up further. Prices are rising in the Asian countries also but, till now, the rates are lower than in the western world.

Mainstream economics advocates contractionary monetary policy to fight inflation. By raising  interest rates and controlling aggregate demand, such a policy helps in keeping price rise under check. However, such a policy is likely to do more harm than good to these economies in the present scenario, where inflation is accompanied by slowdown in output growth. Monetary contraction may work to rein in an overheating economy, i.e., if there is unsustainable increase in aggregate demand which is causing inflation. This is hardly the case today. In the entire capitalist world, output production is slowing down even as prices are rising. Contractionary policies, by restricting demand, would reduce growth rates even further. There is already talk of a possible recession in the US and the European countries and the IMF and the World Bank have revised downwards their growth projections for the world economy.

To understand the current crisis of capitalism one has to go beyond these trends in inflation and output. The capitalism system is ridden with contradictions which make it crisis prone. The system revolves around generation of surplus value and it ends up in a crisis situation whenever there is deficiency or excess of surplus value. In fact, scholars have pointed out that crisis tendencies in capitalism can be classified into two categories – crisis of deficient surplus value and crisis of excess surplus value.2 The former is caused by a fall in the rate of profit that could affect capital accumulation and lead to stagnation. It can arise for two reasons. First, as production expands the demand for labour goes up which could increase the bargaining power of workers. Wage rate tends to rise and if prices cannot be increased the rate of profit tends to fall. The rate of profit also falls with rising capital intensity in production. Productivity goes up with increasing capital intensity and if the wage rate rises faster than productivity the rate of profit declines.

The latter tendency, crisis of excess surplus value, arises when the share of wages falls in national income. Since wages are largely consumed and profits are largely saved and reinvested, when the income distribution tilts in favour of profits it tends to bring down consumption and dampen aggregate demand. This ‘underconsumptionist’ tendency need not always lead the system to crisis as there are countervailing expenditures that generate demand. Nonetheless, the possibility of a crisis will always be there in the system.

This brief detour into theory should help us appreciate the current scenario. The crisis at hand is stagflation i.e., stagnation in output production accompanied by inflation. Policymakers are finding it difficult to grapple with the problem. Such a crisis is not amenable to conventional policy measures. Contractionary policies to rein in inflation would reduce aggregate demand, bringing down production and increasing unemployment. Expansionary policies to stimulate production and increase employment would worsen inflation.

Political economists point out that this phenomenon is typical of the monopoly phase of capitalism. Unlike firms in competitive markets, monopolists can set the prices of their products and they maximise their profits by restricting output and increasing prices. In this way income is redistributed in favour of monopoly capitalists, away from the workers and the smaller capitalists and, as mentioned above, the shift in income distribution in favour of the richer capitalists tends to bring down consumption demand. And as consumption demand slows down, investment demand also tends to  fall. Thus, increasing monopoly power and the attendant shift in income distribution away from the low-income groups create a tendency towards stagnation by reducing aggregate demand and diminishing investment outlets.

State intervention to increase aggregate demand (through expansionary fiscal and monetary policies) would be of little help as monopolists respond to increasing demand with increasing prices rather than output, resulting in stagflation.

The world economy had experienced stagflation in the 1970s after the OPEC (Organisation of the Petroleum Exporting Countries) had jacked up the price of oil. OPEC, which had near monopoly over oil production, placed embargo on oil supply, that increased its profit margin and led to worldwide inflation and output slowdown. Is the capitalist world now staring at another stagflationary crisis? That appears to be the case, if one goes by the available evidence.

The COVID-19 pandemic and the lockdowns induced by it served a big blow to the world economy. The sudden stoppage of economic activities hit the economy from both the demand and the supply sides. Demand was low not only because of falling incomes. Even those whose incomes did not go down did not spend much, except on basic necessities. On the supply side, production of most goods had stopped. Disruption in production clogged the supply chains when lockdowns were relaxed and economies were limping back to normalcy.

The tenuous recovery from the COVID pandemic is now threatened by the Russia-Ukraine war. The IMF has recently, in its World Economic Outlook for the month of April, slashed its own projected growth rates for the years 2022 and 2023. Inflation is not only significantly high in large parts of the capitalist world it is not likely to die down very soon. While the ongoing war is cited as the proximate reason for the output slowdown and the inflation, tendency for stagflation has been building up in the global economy for some time.

World GDP (Gross Domestic Product) came down by 3.1 per cent in the year 2020. But the fall in income was not experienced by all sections of the population. According to an OXFAM report (The Inequality Virus, OXFAM Briefing Paper, January 2021), between March 18 and December 31, 2020, the world’s billionaires saw their wealth going up by $3.9 trillion. The wealth of the top ten billionaires alone went up by $540 million during this period. This is even as hundreds of millions of people were losing their lives and livelihoods.

High degree of inequality in income and wealth distribution is not a new phenomenon in capitalism. In fact, markets, by their very nature, are inequalising. The advent of neo-liberal capitalism in the 1970s only helped in accentuating the trend. According to the World Inequality Report 2022, global income inequality rose steadily from 1820 till 1910. It remained more or less at that level for some time, rose again in the 1970s and again reached a peak during 1980-2000. It came down slightly since then, especially after the financial crisis of 2008, which saw fall in incomes and decline in asset values at the top. The Covid-19 pandemic has again exacerbated the problem. Even as large majority of the people were suffering and struggling to protect their jobs, earn liveable income and get access to healthcare, a tiny minority of the capitalist class virtually profited from the pandemic.

So, the pandemic year saw negative economic growth, widespread job losses and falling incomes, and increased concentration of income and wealth at the top.

After clocking negative growth in 2020, world output grew by 6.1 per cent in 2021. Some part of this growth could be attributed to the low base effect. But the resumption of economic activities as lockdowns were relaxed and lifted in different parts of the world and the pent-up demand also led to this growth rebound. Stimulative fiscal and monetary policies by governments also contributed to it. The increase in demand, albeit tepid, could not be matched by increasing supply due to lockdown induced disruptions in the supply chains. The result is rising inflation.

An important feature of this recovery was that it was uneven. It was led by profits. Corporate profits rose faster than GDP in the US and in many other countries leading to increasing share of profits (and falling share of wages) in GDP, thereby increasing inequality. Bivens decomposes the price increase in the US non-financial corporate sector during 2021 (Q4) to 22(Q2). 53.9 per cent of the price increase was due to increase in corporate profits. Rise in non- labour input costs accounted for 38.3 per cent of the price increase while labour costs accounted for only 7.9 per cent. As against this, during 1979-2019, corporate profits accounted for only

11.4 per cent of the price increase and 61.8 per cent was because of labour cost.3 This is the situation in many other countries. In Canada, wages are rising much slower than inflation while profits are increasing at record rates.4

Increase in income inequality, apart from being undesirable in itself, has macroeconomic consequences, as mentioned earlier. For instance, estimates for the US economy suggest that increasing income inequality brought down aggregate demand by up to 4 percentage points every year during the period 1979-2007.5

This structural weakness of world capitalism, caused by increasing monopoly power, high degree of inequality and reducing share of wages in income has been building up over the years. The COVID pandemic and nature of recovery from it only accentuated the trend.

Moreover, the responses of the governments to the crisis at hand could turn out to be counterproductive. It is feared that rate increases by the central banks could push the economies to recession. The slow growth in tax revenues has led many governments to control their expenditures thereby bringing down the fiscal support to the recovery. All these could dampen demand and derail an already tenuous recovery.

To be sure, the Russia-Ukraine war and the sanctions on Russia have made the global economic scenario even bleaker. The IMF now estimates that the world economy would grow by 3.6 per cent in both 2022 and 2023. In January, the projected growth rates were 4.4 per cent for 2022 and 3.8 per cent for 2023. Inflation has also worsened, especially with rising prices of food and fuel. The IMF has revised upwards its estimates for inflation for the years 2022 and 2023.

Even the cessation of war and the end of the pandemic may not reduce the global economy’s woes. The underlying structural weakness of global capitalism – rising monopoly and high degree of inequality – would continue to push the system towards stagnation. Technical breakthroughs, new discoveries and other changes could delay this process but the threat will always be there unless the structural weakness is addressed. The solution is political, not economic.

link to the malayalam translation –

1 The author teaches Economics at Motilal Nehru College, University of Delhi.

2 Deepankar Basu: ‘Reproduction and Crisis in Capitalist Economies’, in Matt Vidal, Tony Smith, Tomas Rotta and Paul Prew (ed.) The Oxford Handbook of Karl Marx, Oxford University Press, New York, 2019.

3 Josh Bivens: ‘Corporate Profits have contributed disproportionately to inflation. How should policymakers respond?’, Working Economics Blog, Economic Policy Institute, Washington DC, 2022.

4 Jim Stanford: ‘Corporations are Profiting from Inflation’, , accessed on 23-06-2022.

5 Josh Bivens and Asha Banerjee: Inequality’s Drag on Aggregate Demand, Economic Policy Institute, Washington D C, 2022