Are Economic Crises Inherent to Market Economies?

It is interesting to note that Marx, in his analysis of the capitalist economic system, basically concentrates on the study of the imbalances and maladjustments which occur in the market.

This accounts for the fact that Marxist theory is primarily a theory of market disequilibrium and that occasionally it even coincides remarkably with the dynamic analysis of market processes which was developed by economists of the Austrian School, and particularly by Mises and Hayek themselves. One of the more curious points on which a certain agreement exists relates precisely to the theory of the crises and recessions which systematically ravage the capitalist system. Thus it is interesting to observe that certain authors of the Marxist tradition, such as the Ukrainian Mijail Ivanovich Tugan-Baranovsky (1865–1919), reached the conclusion that economic crises originate from a tendency toward a lack of proportion among the different branches of production, a lack Tugan-Baranovsky believed inherent in the capitalist system.1 According to Baranovsky, crises occur because

the distribution of production ceases to be proportional: the machines, tools, tiles and wood used in construction are requested less than before, given that new companies are less numerous. However the producers of the means of production cannot withdraw their capital from their companies, and in addition, the importance of the capital involved in the form of buildings, machines, etc., obliges producers to continue producing (if not, the idle capital would not bear interest). Thus there is excessive production of the means of production.2

Clearly part of the underlying economic reasoning behind this analysis bears a strong resemblance to that behind the Austrian theory of the business cycle. In fact Hayek himself mentions Tugan-Baranovsky as one of the forerunners of the theory of the cycle he presents in Prices and Production.3

Furthermore it is interesting to note that Hayek himself, for a time, came to believe, like Marx, that economic crises were inherent in the capitalist economic system, although Hayek considered them the necessary cost of maintaining an elastic monetary and credit system, the expansion of which, at all times, would “guarantee” economic development. Specifically, Hayek asserted that economic crises arose

from the very nature of the modern organization of credit. So long as we make use of bank credit as a means of furthering economic development we shall have to put up with the resulting trade cycles. They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them. And even if it is a mistake—as the recurrence of crises would demonstrate—to suppose that we can, in this way, overcome all obstacles standing in the way of progress, it is at least conceivable that the non-economic factors of progress, such as technical and commercial knowledge, are thereby benefited in a way which we should be reluctant to forgo.4

This early thesis of Hayek’s, which partially coincides with that of Marx, would only be valid if the very Austrian theory of business cycles had not revealed that economic crises cause great damage to the productive structure and widespread consumption of accumulated capital. These effects seriously hinder the harmonious economic development of any society. Moreover (and this is even more important) the theoretical, legal, and economic analysis carried out here is aimed at demonstrating that economic crises are not an inevitable by-product of market economies, but on the contrary, result from a privilege governments have granted banks, allowing them, with respect to monetary demand deposits, to act outside the traditional legal principles of private property, principles vital to market economies. Thus credit expansion and economic cycles arise from an institutionally-forced violation of the property rights involved in the monetary bank deposit contract. Therefore crises are in no way inherent in the capitalist system, nor do they inevitably emerge in a market economy subject to the general legal principles that constitute its essential legal framework, an economy in which no privileges are conferred.

A second link connects Marxism and the Austrian theory of business cycles. Indeed if any ideology has justified and fed the class struggle, strengthening the popular belief that it is necessary to strictly regulate and control labor markets to “protect” workers from entrepreneurs and their capacity for exploitation, it has precisely been Marxist ideology. Hence Marxism has played a key and perhaps unintentional5 role in justifying and fostering the rigidity of labor markets, and therefore in making the readjustment processes which inevitably follow any stage of bank credit expansion much more prolonged and painful. If labor markets were much more flexible (a situation which will only be politically possible once the general public realizes how damaging labor regulation is), the necessary readjustment processes which follow credit expansion would be much less lasting and painful.

There is a third possible connection between the Austrian theory of economic cycles and Marxism: the absence of economic crises in systems of “real socialism,” an absence many authors have highly praised in the past. Nevertheless there is no point in arguing that economic crises do not arise in systems in which the means of production are never privately owned and all economic processes are coordinated from above through a coercive plan which public authorities deliberately impose. We must remember that depression appears in a market economy precisely because credit expansion distorts the productive structure, so that it no longer matches the one consumers would voluntarily maintain.

Thus wherever consumers lack the freedom to choose and the productive structure is imposed on them from above, it is not that successive stages of boom and recession cannot occur, but rather, with all theoretical justification we may consider that such economies are continually and permanently in a situation of crisis and recession. This is due to the fact that the productive structure is imposed from above and does not coincide with the desires of citizens and it is theoretically impossible for the system to correct its maladjustments and discoordination.6 Therefore to contend that an economy of real socialism offers the advantage of eliminating economic crises is tantamount to affirming that the advantage of being dead is immunity to disease.7 Indeed after the fall of the socialist regimes of Eastern Europe, when consumers were again given the opportunity to freely establish the productive structure most in line with their desires, it immediately became clear that the scale and magnitude of past investment errors would make the readjustment process much deeper and much more prolonged and painful than is common in the stages of recession which affect market economies.

It has become evident that most of the capital goods structure which existed in socialist economies was completely useless with respect to the needs and objectives characteristic of a modern economy. In short socialism provokes a widespread, intense, and chronic malinvestment of society’s factors of production and capital goods, a malinvestment much more severe than that caused by credit expansion. Hence we may conclude that “real socialism” is immersed in a deep “chronic depression,” i.e., in a situation of constant malinvestment of productive resources, a phenomenon which has even been accompanied by cyclical adverse changes and which has been studied in certain detail by various theorists from the former Eastern economies.

The appalling economic difficulties presently confronting the economies of the former Eastern bloc stem from many decades of systematic economic errors. These errors have been much more serious (and have been committed at a much more rapid pace) than those which have regularly appeared in the West due to credit expansion by the banking system and to the monetary policy of public authorities.

Excerpted from Money, Bank Credit, and Economic Cycles

• 1.Tugan-Baranovsky, Industrial Crises in England. Spanish translation included in Lecturas de economía política, Francisco Cabrillo, ed. (Madrid: Minerva Ediciones, 1991), pp. 190–210. See also chapter 7, footnote 87.
• 2.Excerpt translated from Spanish edition. Ibid., p. 205; italics added
• 3.In the German literature similar ideas were introduced mainly by the writings of Karl Marx. It is on Marx that M.V. Tougan-Baranovsky’s work is based which in turn provided the starting point for the later work of Professor Spiethoff and Professor Cassel. The extent to which the theory developed in these lectures corresponds with that of the two last-named authors, particularly with that of Professor Spiethoff, need hardly be emphasised. (Hayek, Prices and Production, p. 103)

  See also Hayek, The Pure Theory of Capital, p. 426. On Tugan-Baranovsky and the content of his doctoral thesis, The Industrial Crises in England, see the biographical article on this author by Alec Nove, published in The New Palgrave: A Dictionary of Economics, John Eatwell, Murray Milgate, and Peter Newman, eds. (London: Macmillan, 1987), vol. 4, pp. 705–06. The error in all of these doctrines of a “lack of proportion” lies in the fact that they disregard the monetary and interventionist origin (in the form of the privileged operation of the banking system) of such a lack, they fail to recognize the entrepreneurial tendency to detect and correct maladjustments (in the absence of state intervention) and they naively assume that government economic authorities possess a deeper knowledge of these effects than the network of entrepreneurs which act freely in the market. See Mises, Human Action, pp. 582–83.

• 4.Hayek, Monetary Theory and the Trade Cycle, pp. 189–90. In 1929 the young Hayek added that, in his opinion, a rigid banking system would prevent crises, but “the stability of the economic system would be obtained at the price of curbing economic progress.” He concluded, It is no exaggeration to say that not only would it be impossible to put such a scheme into practice in the present state of economic enlightenment of the public, but even its theoretical justification would be doubtful. (Ibid., p. 191)
• 5.In fact Marx himself considered the interventionist and syndicalist versions of socialism “utopian” and even stated that welfare and labor legislation aimed at benefiting workers would invariably be ineffective. In this sense he fully accepted the classical school’s arguments against state regulation of the market economy. Marx’s position on this issue in no way lessens the fact that Marxism, quite unintentionally, was the main ideological force behind the “reformist” movements that justified intervention in the labor market.
• 6.We have completely devoted the book, Socialismo, cálculo económico y función empresarial, to demonstrating why it is impossible for a system of real socialism to exert a coordinating effect through its policies even under the most favorable conditions.
• 7.A dictator does not bother about whether or not the masses approve of his decision concerning how much to devote for current consumption and how much for additional investment. If the dictator invests more and thus curtails the means available for current consumption, the people must eat less and hold their tongues. No crisis emerges because the subjects have no opportunity to utter their dissatisfaction. Where there is no business at all, business can be neither good nor bad. There may be starvation or famine, but no depression in the sense in which this term is used in dealing with the problems of a market economy. Where the individuals are not free to choose, they cannot protest against the methods applied by those directing the course of production. (Mises, Human Action, pp. 565–66)