Thursday, December 11, 2008

What happens in a recession - why Venezuela´s socialist economic orientation is crucial in the international financial crisis

Venezuela´s socialist economic orientation is usually judged from the point of view of moral criteria - the improvement of the living standards of the majority of the population. But it also has a decisive practical aspect, in the current situation for example the protection and development of the Venezuelan economy in the context of the global economic crisis. The socialist orientation of Venezuela's economy gives it by far the best opportunity to deal with the impact of the international financial crisis. In order to understand this it is vital to understand what occurs in a recession.
In the development of a recession, such as the one the world economy is entering, what is decisive is not consumer or government spending. What, above all, occurs in a recession is that investment declines or, in the most severe cases, collapses.
In order to illustrate this Figure 1 shows the changes in the main domestic components of US GDP in the most classic of all recessions/depressions - that in the US following 1929. [1]

Figure 1

As can be seen the pattern is clear. The economic decline in US was extremely severe - on a far larger scale than anything occurring at present. The fall in US GNP (Gross National Product) was 29.7 per cent between 1929 and 1933.[2] The 1929 US level of GNP was not regained for a decade - until 1939.
Looking at the components of this decline in GDP, however, a clearly differential pattern shows itself.
Government spending increased throughout the recession - not only after Roosevelt became president in 1933 but even under Hoover.
The decline in personal consumption expenditure after 1929 was severe but less than the overall decline in GNP. By 1933 US personal consumption expenditure had fallen by 19.7 per cent compared to the 29.7 per cent drop in GNP. Personal consumption expenditure regained its 1929 level by 1939.
But the collapse in investment was extreme, far exceeding the decline in GNP - explaining the difference between the drop in personal and government consumption expenditure and the drop in overall output
By 1933 US private domestic fixed investment had fallen by 73.9 per cent from its 1929 level. Or, put another way, by 1933, US private domestic fixed investment was only 26.1 per cent of its 1929 level. This was by far and away the most severe element of the depression - which, by multiplier effects, spread its consequences through the rest of the economy. Similar patterns are seen in any recession.
The reason for this differential decline is that while 'demand' in the economy may be spoken of in general, in fact the different components of demand are controlled by quite different mechanisms.
Decisions on the level of government spending are taken directly by the state and can therefore be relatively easily controlled - here Venezuela's socialist orientation gives a good opportunity to maintain demand during the international recession.
Regarding personal consumption, the aim of the mass of the population is to have as good a living standard as possible. The most powerful issue affecting personal consumption is the level of income, not the desire to consume. [3]
However, private investment decisions are not controlled by consumption but by profit. Therefore investment decisions are not controlled by the same mechanisms as personal and government consumption - and can fall to almost any level. It is this decline in investment which is by far the largest in a recession.
Why, therefore, cannot a capitalist government intervene directly to stop the decline in investment? The issue here is private property in the means of production. If the government takes decisions on investment out of the hands of the private owners of the means of production it, in fact, limits or abolishes that private ownership of the means of production. Therefore, in such circumstances, if the government accept the private ownership of the decisive means of production in a country it cannot halt the decline in investment. Whereas if, in such circumstances, the government aims to halt the decline in investment it must have sufficiently strong instruments, in terms of the weight of the state owned sector, in order to prevent investment in the economy declining.
Confronted with the severe international financial crisis, if the decisive sectors of Venezuela´s economy were privately owned it would not be possible to halt the decline in investment. Venezuela´s economy would go into severe recession. The fact that in Venezuela important sectors of the economy are state owned, and it has a socialist economic orientation, means that the government can directly intervene to keep up investment. This means that Venezuela is in a much better position to resist the international financial crisis than if it were not a socialist government.
The practical consequences in terms of economic policy are clear. The core of givernment policy to deal with the international financial crisis must have three components.
Firstly, in order to avoid a decline in demand in the economy personal consumption must be maintained at a high level in the economy.
Second, government spending must be maintained, and increases may be necessary, in order to complement the high level of consumer demand.
Third, and most important, strong state measures must be taken to maintain and increase the level of investment in order to compensate for what will almost certainly be a decline in private investment due to the effect of the international economic recession.
The aim of this investment, in addition to its immediate effect in maintaining demand in the economy, must be both to increase the long term efficiency of the economy and to improve the quality of life of the population. In most countries, both China and the US being examples, the most effective means to achieve this is a sharp increase in spending on infrastructural investment.
Such counter-cyclical programmes will, of course, be even more effective if co-ordinated with Venezuela´s Latin American partners.

[1] The international source of demand is net exports. There was a drastic contraction of international trade after 1929 which seriously deepened the depression. However this does not affect the argument regarding the components of domestic demand dealt with here. Inventories also declined after 1929, adding to the recessionary effect, however changes in stocks, by their nature, are cyclical and again the concentration here is on the long term elements in economic shift.
[2] Gross National Product (GNP) differs from Gross Domestic Product (GDP) in that is equal to GDP plus net income earned from abroad. Long term US historical economic data is in GNP terms. The size of difference to GDP is, however, small and does not seriously distort comparisons to other countries GDP figures.
[3] In a recession personal consumers may decide to save more - among other reasons to protect themselves from the threat of future economic hardship or unemployment. However there are relatively effective mechanisms to tackle this, and in any case if the extra savings are invested by the government or companies no fall in aggregate demand takes place - the savings by individual are merely spent somewhere else in the economy. The biggest effect is the fall in income due to either declines in real wages or unemployment.


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