Economic crisis refers to a situation whereby an economy of a particular country undergoes a sudden downturn arising from a financial crisis (p.14). During an economic crisis, most economies tend to experience a reduction in growth in their Gross Domestic Product.
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These economies also undergo a reduction in the liquidity level in addition to fluctuation in prices due to deflation and inflation. There are different forms that an economic crisis can take. These include depression of a recession. This paper is aimed at analyzing the concept of economic crisis. To achieve this, the paper takes into account classical views, Marxist view and Keynesian views. Additionally, the paper also evaluates whether these views are still held today.
The history of economic crisis
The concept of economic crisis was first developed by two economists by the name Kenneth Rogoff and Carmen Reinhart during the 19th century. These economists traced the economic crisis to early 1340’s when England experienced an economic crisis as a result of its war with the French (p.87).
There were also other economic crises which were experienced in different parts of the world. For example, in 1637, Netherlands experienced an economic crisis as a result of a bursting of a bubble referred to as the Tulip Mania. The Tulip Mania was widely known to be a speculative bubble.
In 1720, there were other economic crisis in Britain and France which resulted from the bursting of economic bubbles known as South Sea Bubble and Mississippi Bubble respectively. The 19th century was also characterized by a number of economic crises. For example, the Danish state bankruptcy which was experienced in 1893 led into an economic crisis. Over the past three centuries, a number of economic recessions have been experienced in different countries.
Assumptions of economic crisis
The concept of economic crisis was developed by a number of economists. These economists can be categorized into two, that is, the Marxists and Keynesians. The two categories of economists held varied opinion regarding economic crisis. According to Marxists, economic crisis is associated economic crisis with overproduction within the capitalist economy.
These economists opine that capitalists produce too may goods than they can be sold for profit. Additionally, these economists assert that a lot of investment is undertaken in an effort to maximize on the firm’s profitability. Additionally, these economists assert that economic recession arises from accumulation of capital.
Marxism and Keynesian view of economic crisis
In his view, Karl Marx associated economic crisis with the capitalist economy. Marx was of the view that forces that drive a capitalist economy are unstable and self-destructive. Growth in capitalist economy is usually disproportionate in that it is associated with an increase in disequilibrium. Accumulation of capital within such an economy leads to a prolonged underinvestment.
Karl Marx further asserts that if a capitalist economy is not checked by external shocks such as skyrocketing oil prices and World Wars, it will continually experience economic crisis (p. 151).These views are also held by post Keynesians, Marxists and institutionalists who assert that capitalist institutions result into emergence of economic recessions and depression.
In a capitalist economy, the system is designed in such a way that it is mainly focused at creating wealth through increased production. The resultant effect is that the supply of goods becomes high than the prevailing demand. At this point, an economic downturn is stimulated as the economy tries to rebalance itself.
In his view, Karl Marx explains the economic crisis on the basis of aggregate demand. Marx asserts that the rate of consumption from profit is relatively low compared to consumption out of wages. This arises from the fact that capitalists will tend to save or invest most of their profits. As the capitalist economy expands, productivity rises leading into an increment in supply.
Over production -Under-consumption approach of the Marxist
During periods of economic prosperity, capitalists increase their volume of production. To achieve this, they invest more in fixed capital such as machinery and buildings. The investment leads into an increment in the volume of goods produced within the market.
The resultant effect is that a crisis ensures. In the classical theory of economic crisis, over-production is associated with a decline in the rate of production and trade. Over-production further causes a general fall in price of commodities thus leading into emergence of a deflationary spiral. According to Karl Kautsky who was a German Social Democrat, economic crisis arises from under-consumption.
In his view capitalists increase their capital as a result of increased productivity but they do not reciprocate this growth by increasing the wages and salaries of their workforce proportionately. This means that the workers are exploited. This means that the capitalist economy is also characterized by under consumption. The consumers’ purchasing power is adversely affected. This arises from the fact that the proportion of wage to the profits decline as the economy expands.
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The resultant effect is that aggregate demand becomes limited. Additionally, the work environment is characterized by negotiations and strikes as the workers try to negotiate wage increases. This means that unemployment results into an increment in the employees bargaining power. Reduction in the rate of consumption means that only a small proportion of the companies’ products are bought. However, their production continues to leading into accumulation of commodities.
Lack of sufficient market for the goods produced results into the organizations incurring high operation costs. In an effort to reduce their operation cost, the capitalist organizations incorporate the concept of downsizing whereby they lay-off some of its employees leading into mass unemployment. For example, the Great Depression of the 1930’s led into a massive loss of jobs in the US. For a considerable duration of the 1920’s the rate of unemployment averaged 4%. The economic depression led the rate to grow to a high of 25% by 1932.
This means that the level of unemployment which was relatively low during the boom begins to rise (p. 41). Individuals who are laid off cannot be able to purchase the goods produced through overproduction since their purchasing power is adversely affected.
Capitalist economy is widely known to cause endemic poverty and recurring economic booms and slumps (p.57). The resultant effect is that the rate of unemployment within the economy increases culminating into a decline in the rate of economic growth. This further causes periodic crisis.
As the capitalists increase their volume of production, they have to find a market that is still not capitalistic. When they find the non-capitalistic market, their objective is to expand their market. However, the rate of expansion in the market is relatively low since the market does not have the ability to handle the expansion arising from capitalist process of production.
Upon the capitalist production developing a large industry, its expansion rate becomes so high that it is possible to overtake other market expansion. However, the expansion is short-lived and it ends in a crisis. Decline in aggregate demand causes economic crisis. This phenomenon existed during the Great Depression of the 1920s. As a result of economic crisis, a rise in economic recession is experienced.
Keynesian view -Full employment profit squeeze
According to the Keynesian economists, capital accumulation results into a pull for demand with regard to labor. According to Keynes, profit squeeze arises from pressure of growth in productivity. Increase in productivity leads into an increase in level of employment within the economy.
However, growth in productivity is at a lower rate compared to growth in wage. As a result, there is an increase in pressure for the accumulated profits. This in turn pressurizes the rate of growth in capital stock growth. Profits are an important component of accumulating capital.
This arises from the fact that a significant proportion of capital in organizations is saved thus enhancing accumulation of capital. Due to a decline in the amount of realized profits, organizations anticipate a reduction in their profitability in the future.
The resultant effect is that organizations decline their demand for investment. In summary, growth in employment stimulates growth of wages and salaries. However, this limits growth of profitability. The overall effect is that more pressure is put on the organization’s profits culminating into a crisis of accumulation. According to Keynesian economists, rise in wages and salaries, hurts organizations profitability hence leading into a recession.
Validity of the concept of economic recession
The reasons for the emergence of economic crises advanced by classical and Keynesian economists are still valid today. For example, according to Karl Marx, the economic crisis experienced in different economies at different time had something in common. One of the issues which link these economic crises is over-production.
For example, the economic crisis experienced in 1857 was as a result of over-investment in rail development in order to increase production. This was also replicated in 1873 in Europe’s construction industry while the economic depression experienced in 1929 was a result of over-production in the various economic sectors.
The economic crisis experienced in the 21st century was as a result of over-production within the housing industry. The housing industry experienced a boom for a considerable duration of the first decade of the 21st century (p. 95). However, there was poor planning by the financiers and investors in the sector. This is evident in that financial institutions advanced loans to investors who could not be able to repay in order to repay the loans.
Decision to advance loans to these investors was aimed at increasing their level of profitability. During this period, the housing industry was experiencing high short term profits. As more investors’ sought finances from financial institutions in order to purchase homes, the industry experienced a significant growth in the level of short term profitability. However, the profits were short-lived and the bubble busted causing a collapse of the housing industry.
Economic crisis is an important element in the decision making process in organizations especially in capitalist economy. In their operation organizations are aimed at maximizing their profit (p. 189). However, their production should be inline with the existing market demand.
This means that in their quest to increase their profit, they should not overproduce. Additionally, organizations align their wages and salaries policy with their increase in profitability. This will safeguard against a possible decline in demand for their commodities which may arise from a decline in the consumer’s purchasing power.
Despite the adverse effect of the 2008 financial crisis on the financial and housing industry, the financial crisis cannot explain why there were massive losses of job around the world (p.54). For example, the financial problem experienced by automobile firms such as General Motors was not directly linked to the financial crisis. However, it was as a result of poor planning. Therefore, organizations should be very effective in planning their production process.
The analysis illustrates that the concept of economic crisis has been in existence for a long duration of time. A number of economists have given their opinion regarding the concept of economic recession. These economists have postulated different causes of economic recession. According to Marxist economists, economic crisis is caused by over-production and under-consumption. Organizations produce a large volume of goods which is not inline with the existing demand.
Decline in demand for the firm’s commodities makes organizations to downsize their operation by laying-off some of its employees. In order to deal with this, most organizations incorporate the concept of downsizing by laying-off some of its employees. The resultant effect is the rate of unemployment increases culminating into a slowdown in the rate of economic growth. This forces the economy to slump into economic recession.
According to the Keynesian economists, most organizations are aimed at maximizing their profitability. In order to attain this, they increase their capital investments for example by increasing their investment in machinery and building in an effort to enhance their production capacity.
Upon increasing their profitability, the organizations do not reciprocate by increasing the wages of the employees. The resultant effect is a general reduction in demand for their commodities is experienced. This culminates into a reduction in their profitability. In an effort to ensure a decent pay, employees engage in negotiations and strikes which result into a decline in the firms’ productivity.
The assumptions advanced by the Marxist and Keynesian economist on economic crisis are still valid today. For example, the recent global economic crisis which originated from the US was as a result of overproduction within the housing industry.
During the onset of the 21st century, the housing industry was characterized by a rise in short term profits which led into an increase in the number of investors who ventured into the industry. In an effort to maximize their profits, financial institutions advanced financial credit to individuals who were not able to pay. The resultant effect was an increase in the rate of defaults.
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