Finance Capital and Fiscal Deficits Prabhat Patnaik

One of the central paradoxes in economic theory relates to the hostility that financial interests in a modern capitalist economy systematically display towards any policy of enlarged State expenditure financed by borrowing, even though such expenditure increases capitalists’ profits and wealth.

Let us suppose that the government undertakes a larger borrowing-financed public expenditure programme, and that all borrowing is from domestic sources. Then corresponding to the increase in government borrowing, there must be an equivalent increase in the excess of private savings over private investment. Since private investment expenditure is more or less given in any period, a result of past investment decisions, a rise in government borrowing creates an equivalent increase in private savings. Since such savings depend upon post-tax profits (surplus), there must be a rise in post-tax profits (surplus); and what is more, this rise is some multiple of the rise in government borrowing.

An example will clarify the point. If, say, one-half of post-tax private profits (surplus) is habitually saved, then a rise in government borrowing by Rs.100 at base prices will raise private surplus by Rs. 200 at base prices in order to generate Rs.100 of private savings to finance itself. This will happen in a situation of less than full employment through an increase in output and employment, while the base prices themselves remain more or less unchanged; in a situation of “full employment” (supply constraint) this will happen through profit inflation squeezing out “forced savings” from the workers. The capitalists as a whole in other words earn an additional amount that is a multiple of the increase in government borrowing.

In his book How to Pay for the War, the well-known English economist John Maynard Keynes had called this additional profit of the capitalists “a booty” that fell into their lap. He was talking about increased government borrowing to finance war expenditure in a situation where the scope for raising output and employment was limited, and he was assuming that the whole of the additional profits accruing to capitalists was saved. In such a case, if government expenditure rose by Rs.100, then there would be inflation that would squeeze workers’ consumption, and simultaneously boost profits. Hence, while the actual resources for meeting war expenditure came from the workers whose consumption was reduced by an equivalent amount, the capitalists’ wealth increased by Rs.100 despite their having done nothing. It is as if the government snatched away Rs.100 from the workers, put it in the lap of the capitalists, and then borrowed this Rs.100 from them. The real “sacrifice” for the war in other words was made by the workers, while capitalists’ wealth went up gratuitously. The “unfairness” of this had prompted Keynes to argue that even if the government had to snatch away Rs.100 from the workers, the capitalists must not be handed over this amount as “booty”, i.e. war expenditure must be financed through taxes.

In Keynes’ example, supplies could not be increased and hence the rise in profits occurred through inflation. But if supplies can be increased then larger government borrowing still increases the magnitude of profits, but through an increase in output not prices. Larger government borrowing in short invariably boosts capitalists’ profits and wealth.

But this brings us back to the question that if a borrowing-financed increase in government expenditure hands over a “booty” to the capitalists that is some multiplier (greater than or equal to one) times this expenditure increase, then why are the financial interests opposed to such an increase? Why for instance do they favour the principle of “sound finance” and insist on the passage of Fiscal Responsibility Legislation everywhere to limit the size of the fiscal deficit?

One can give certain obvious economic explanations. The first is the fear of inflation. Larger government expenditure by raising the level of aggregate demand will cause inflation which will lower the real value of all financial assets, something which finance capital obviously dislikes. This explanation is not without weight, but it fails to explain why the opposition to borrowing-financed government expenditure should persist even in the midst of a Depression when the increase in aggregate demand is likely to cause almost exclusive output adjustment with very little impact on prices.

The same holds for the other possible economic explanation for their opposition, namely a fear of worsening of balance of payments and hence of a depreciation of the currency, which again would lower the value of financial assets, but in terms of other currencies. A whole lot of measures, however, ranging from import controls to increased external borrowing, are available to the government that is stimulating the economy. These measures can keep the fear of any currency depreciation at bay. The fear of currency depreciation therefore cannot also be an adequate explanation.

It follows then that economic explanations for the opposition of finance to increased borrowing-financed government expenditure are inadequate. The real basis of the opposition is political. As the Marxist economist Michael Kalecki had once remarked, profits are not everything for the capitalists; their class instincts too are important. And these class instincts tell finance capital that a proactive expenditure policy of the State, even for the purpose of demand management, is detrimental to the long-term viability of the system in general, and of the financial class in particular.

The mythology propagated by capitalism is that the unfettered functioning of the system gives rise to a state of full employment where the resources are efficiently allocated. This myth of course cannot be sustained, since even the most die-hard believer in the ideology of capitalism cannot deny the real-life existence of periodic Depressions and the virtually perennial state of demand-constraint that afflict the system. Depressions are usually explained in bourgeois theory in terms of a setback to the “state of confidence” of the capitalists. It follows then according to bourgeois theory that if a capitalist economy is doing poorly then the remedy for it lies in providing greater support and concessions to the capitalists so that their “confidence” will revive, and with it the economy.

But if government expenditure can be used to revive the economy, then “the state of confidence” of the capitalists ceases to be of paramount importance. The very fact of the economy’s revival will itself, if anything, bolster their “state of confidence”; and even if their “state of confidence” is not revived fully, the government can still stabilize the economy at a high level of employment. What is more, since the adverse effect of government measures for reducing income and wealth inequalities in society, like profit taxation or property taxation, on the “state of confidence” of the capitalists, can be counteracted by government expenditure, so that unemployment need not result from such measures, the government can adopt them with impunity. Thus a government that can use public expenditure to sustain the level of activity in the economy need not bother much about the “state of confidence” of the capitalists and hence can bring about far-reaching changes in the system, including, where necessary, the induction of public enterprises.

There is no reason why such public enterprises should be any less “efficient” than private enterprises in an engineering sense, i.e. in terms of physical input use; but even if perchance they are, an economy, with public enterprises, functioning close to “full employment” will still have a larger volume of goods at its disposal for given input endowments than a free market capitalist economy. In short the “social legitimacy” of capitalism gets seriously compromised by the fact that State expenditure can take the economy to near-full employment irrespective of the “state of confidence” of the capitalists.

In a modern capitalist economy the barometer for the “state of confidence” of the capitalists is the state of exuberance of the stock market, i.e. the state of euphoria of the financial interests. If State expenditure can sustain a near-full employment level of activity in the economy, then the exuberance of the financial capitalists ceases to be a matter of much concern. Governments can pursue whatever policies they consider socially desirable without having to concern themselves with the impact of such policy on the exuberance of the financial capitalists.

True, the maintenance of the economy at near-full employment may cause accelerating inflation because of the exhaustion of the reserve army of labour, but governments, under working class pressure, may become emboldened to attempt to resolve such problems through even more radical measures, such as prices and incomes policies, nationalizations, workers’ management of factories etc. Once the “state of confidence” of the capitalists is given short shrift, then there is nothing to prevent the economy’s ideological “slide” to radical social engineering and even to socialism.

It is vital for finance capital therefore that the ideological weight of the proposition that the “state of confidence” of the capitalists is crucial for the well-being of society is not diminished one iota, for which the proposition that State expenditure can boost employment with impunity must be attacked, no matter how flawed in logic the attack may be.

This fact has a direct bearing upon the question of recovery from the current world recession. The need for increasing government expenditure for overcoming this recession is widely recognized. And it is also recognized that it is better for recovery if this increase in government expenditure is coordinated across the major countries rather than being sequentially undertaken in an uncoordinated manner by individual countries.

But no such initiatives for recovery can be undertaken because of the opposition of the financial interests to fiscal deficits. It is significant that at the G-20 meeting in end-March there was no mention of any fiscal stimulus, let alone of any coordinated fiscal stimulus. While in the immediate aftermath of the financial crisis, in September and October, there was much talk of a coordinated fiscal stimulus, that talk has died down now. True, the United States and China have announced what appear at first sight as sizeable fiscal stimulus packages. But the actual stimulus in the United States, at least, as distinct from the increase in fiscal deficit caused by the maintenance of government expenditure in the face of a decline in tax revenue, is quite small. This is because much of the increase in federal government expenditure announced by the Obama administration as part of its stimulus package will merely offset the curtailment in government expenditure in the various States of the U.S. on account of the decline in their tax revenues.

By contrast, the “bail out” package to the financial system in the United States is estimated to exceed $10 trillion. The strategy at present therefore seems to be to sustain the financial system and wait for the next “bubble” to appear rather than to revive the real economy directly through fiscal stimuli. The consequence of this strategy will be a prolonged period of recession and unemployment with much human suffering; but this only underscores the power of the financial interests in contemporary capitalism, where even a crisis of this magnitude engendered by their functioning leaves this power undiminished.