As last year’s economic slowdown turned into a financial crisis, and the financial crisis into a global recession, there has been more and more reference to the Great Depression of the 1930s, as well as to the less severe downturns that have punctuated the decades since World War II. There is little mention, however, of the fact that business depressions have been a recurrent feature of the capitalist economy since the early nineteenth century, inspiring a vast literature of theoretical attempts to understand them and statistical materials for identifying and tracking them.

Perhaps the venerable concept of the “business cycle” makes few appearances in current economic commentary in part because post-war downturns were mild and short in comparison to earlier ones (economic history from the early 1800s to the late 1930s was about equally divided between prosperity and depressions, which became deeper and longer over time). The claims of Keynesian economists, after 1945, to have ended the business cycle by “fine-tuning” the economy with governmental controls did not survive the combination of inflation and stagnation that set in the 1970s. Yet the ability of the economy to bounce back quickly from hard times led newly confident “neoliberal” economists to insist that capitalism is simply prosperous by nature.

In reality, the current worldwide slump, far from a mysterious anomaly, represents the return of the capitalist economy to the dark side of its pre-World War II history.

The boom-bust cycle started up as soon as the growth of a money-centered economy and the Industrial Revolution led to the establishment of capitalism in wide enough swaths of territory for it to become the dominant social system. Before that, of course, economic life was disrupted by a variety of disturbances: war, plague, bad harvests. But the coming of capitalism brought something new: starvation alongside good harvests and mountains of food; idle factories and unemployed workers in peacetime despite need for the goods they produced. Such breakdowns in the normal process of production, distribution, and consumption were now due not to natural or political but to specifically economic factors: lack of money to purchase needed goods, profits too low to make production worthwhile. Major downturns have been identified in every decade from the 1820s forward, increasing steadily in seriousness up to the Big One in 1929. All of these moments saw declines in industrial production, sharp rises in unemployment, falling wages (and other prices), and failures of financial institutions, preceded or followed by financial panics and credit crunches. In every case, the downturn was eventually followed by a return to greater levels of production (and employment) than before. At first only the most capitalistically developed nations were affected (the 1825 crisis took in only Great Britain and the United States). But over the next hundred years, as capitalism spread across the world and countries were increasingly linked by trade and capital movements, the cycle of crisis and recovery took in ever more areas, although not all experienced these phases in the same way, to the same extent, or at the same moment.

While early-19th century champions of the free market—the ancestors of today’s neoliberals—insisted that a general crisis of the economic system (as opposed to temporary disequilibria) is simply impossible, other economists responded to the evidence by speculating as to the causes of the cyclical pattern. The fact that in a market economy decisions about where to invest money and so about what is produced, and in what quantities, are made prior to finding out what quantities of particular goods are actually wanted by consumers, and at what price, seems obviously relevant to recurrent fluctuations in economic activity, in which different parts of a complex system adjust to each other over time. Another basic aspect of capitalism—that the total money value of goods produced must be greater than the total money paid out in wages in order for profit to exist—suggests an inherent imbalance between production and eventual consumption. As both of these are constant features of this society, however, it is hard to see how they can explain the alternation between periods of growth and collapses serious enough, on occasion, to give large numbers of people the idea that the system was actually breaking down. Economists searched for explanations lying outside the economy proper, such as sunspots, whose cyclical increase and diminution seemed to match the economic data closely, and might conceivably affect the economy through effects on agriculture. Other theories looked at waves of optimism and pessimism, perhaps caused by changes in death rates, to explain increases and decreases in business investment.

A more plausible explanation of the cyclical pattern, in terms of the changing profitability of investment, emerged from the major survey of economic data carried out over many decades at the National Bureau of Economic Research in Washington by economist Wesley C. Mitchell and his associates. Profit—I quote Mitchell’s words, but it is a commonplace concept—is “the difference between the prices which an enterprise pays for all the things it must buy, and the prices which the enterprise receives for all the things it sells.” Since a business enterprise must regularly turn a profit to continue to prosper, “the making of profits is of necessity the controlling aim of business management” and decisions about where to invest and so what to produce are regulated by the quest for profit. At some times businesses do better across the economy as a whole, earning more profit on the average, than at other times. And when average profits are high society enjoys prosperity, but declining profits can lead to depression.

What determines these changes in the profitability of capital investment? This question—which Mitchell did not really answer—bears not only on capitalists’ expectations and so their willingness to invest funds, but also on their ability to invest, since the money available for investment is either drawn from existing profits or borrowed against future profits, which must then come into existence if loans are to be repaid. The question as to the average size of profits produced at any time, just because it is so basic, takes us to the heart of the economic system. As Mitchell explained the regulation of business decisions by the need for profit, “industry is subordinated to business, the making of goods to the making of money.” But what determines the size of the difference between money costs and sales prices that is collected as profit?

To quote Mitchell once more, in a modern business economy, “most … economic activities have taken on the form of making and spending money.” We are so used to this state of affairs that we hardly notice its historical peculiarity and forget that in the past—in much of the world, even the very recent past—most people produced much or most of their own food, clothing, and other necessities of life. So it is worth while remembering that, while money appears in many types of society, capitalism is the only one in which it plays a central role in the production and distribution of goods and services, so that nearly every object and service that we make use of in the course of a day has had to be purchased for money.

Money is basic to capitalism because this is the first social system in which most productive activity—apart from the few tasks that people still perform for themselves, like (sometimes) cooking dinner, brushing their teeth, or hobbies—is wage labor, performed in exchange for money. Most people, lacking access to land, tools, and raw materials, or enough money to purchase these, cannot produce the goods—housing, clothes, food—they need; they must work for others who have the money to hire them as well as to supply materials and tools. This money flows back to the employers when employees purchase goods they—as a class—have produced. Meanwhile, employers buy and sell goods—raw materials, machinery, consumer goods—from and to each other. Thus flows of money connect all the individuals involved in one social system.

The people who produce goods for a business have no direct relationship with the people who will buy and consume those goods or services, even though it is ultimately for these consumers that they are producing. The workers in bakeries and automobile factories do not know who will buy the bread and the cars they make, or what quantities they want and can afford. The same is true of their employers. Though capitalist businesses produce to meet the needs of anyone who can pay, as the property of individuals or corporations they are linked to the rest of society only by the exchange of goods for money, when they buy materials and labor and when they sell their products. This is why each business only finds out from its success or failure in selling its products, at sufficiently high prices to make a profit, to what extent it is meeting the needs of customers. It is only when products are sold and consumed that the labor that has made them counts as part of the total work performed under the employer-employee system that is the dominant form of production. If the goods aren’t sold, the work done to produce them might as well not have been done, for they will not be used. It is thus the network of exchanges against money that binds all forms of work together into an economic system. Money is central to modern society, a society based on the principle of individual ownership (even though the vast majority of people don’t own very much) because it represents the social character of productive activity in a form—bits of metal, paper symbols, or electronic pulses—possessable by individuals.

Like all forms of representation, money is an abstracting device: by being exchangeable for any kind of product, money transforms the different kinds of work that make these products into elements of an abstraction, “social productive activity.” The abstract character of modern production is not only an idea, but has social reality: for businesses, the particular product they sell is of interest only as a means to acquire money that, as a representation of social productive activity in general, can be exchanged for any sort of thing. Executives move capital from one area of business to another not because they care more about automobiles than soybeans or stuffed animals, but to make money. This is what “capital” is: money used to make money. A business that does not make a profit will cease to exist, so the ability to make money—to increase the quantity owned of the representation of social productive activity—constrains what goods are produced, or even whether money is invested in the production of goods at all.

The fact that money is the most important practical way in which the social aspect of productive activity is represented allows it to misrepresent social reality as well. By being exchanged for money, natural resources like land and oil deposits are represented in the same terms—as worth sums of money—as humanly produced things. Interest—more money—must be paid for the use of someone else’s money. Things that are simply symbols of money, like IOUs, including complicated IOUs like banknotes and stocks and bonds issued by companies, can be bought and sold, since they entitle their owners to money incomes and so can be treated as if they were saleable products. And since goods must be priced so that their sale allows businesses to make a profit, even in the case of actual products the amount something costs is affected by the amount people are able and willing to spend on it.

As a result, profit, as a portion of the sales price, misleadingly appears to be generated by the activities of particular firms, especially because it is appropriated by individual businesses, who compete with each other to get as much of it as possible. In reality, profit—because it exists in the abstract form of money, rather than in that of particular kinds of product—must be produced by the whole network of productive activities held together by the exchange of goods for money. It is with the goal of making money that employers buy equipment and materials from each other and labor from employees, who in turn buy back the portion of their product not used to replace or expand the productive apparatus and—let’s not forget—to provide the employers with their own, generally expensive, consumables. The capitalistically-desired output of this whole process, profit, is the money-representation of the labor performed beyond that required to reproduce the class of employees (paid in the form of wages) and to provide the goods required for production. It is the whole social system that produces profit, though individual companies get to keep it.

The social character of profit can be seen in the very fact that the level of profitability on capital investment alters over time, independently of the wishes of businessmen, who, like everyone else, must adapt to the price movements that determine how well they do (it is this that gives rise to the idea of “the economy” as a set of impersonal forces like the laws of nature.) Competition for profit forces businesses to charge similar prices for similar products; since they must themselves buy goods (labor and materials), their ability to compete by lowering prices depends on the production techniques they employ. In this way, the social character of the system asserts itself through pressure on individual firms to raise productivity, insofar as this leads to higher profits.

Historically, this has led to a strong tendency towards decreasing the labor force in comparison to the amount it produces (while, of course, increasing the number of workers absolutely as the system grew). Employers first made labor more productive by assembling workers into large workshops, within which their work was divided into smaller and smaller tasks. This led to the substitution of machines for people, whenever this raised profitability, and to the invention of the modern assembly line, whose speed enforced high levels of labor intensity. By the end of the twentieth century, most production had become mechanized mass production, requiring less and less labor relative to a growing quantity of machinery and, of course, raw materials.

This shift has obvious consequences for the profitability of capital. If profit is the money-representation of the labor performed by employees of all of society’s businesses in excess of the work required to replace raw materials, tools, and those employees themselves, then it will decline relative to total investment if businesses increasingly invest more of their money in machines and materials than in labor. Karl Marx, who first figured this out, called it “the most important law of modern political economy”: the tendency of the rate of profit to fall. Marx’s explanation of the tendency to declining profits, noticed well before him by nineteenth-century economists, is a controversial one, to say the least. But it led to a prediction that has proved all too correct: that the history of capitalism would take the form of a cycle of depressions and prosperities. And it explains the correlation Mitchell demonstrated between changes in profitability and the business cycle.

Marx pointed out that the growth of capitalism, with its bias towards mechanization, led to an increase in the amount of money needed to continue to expand production, and so to the increasing size of individual companies. For the largest 100 firms in the United States, for instance, in real terms the amount of money invested in equipment per worker doubled between 1949 and 1962. And, of course, as increasing mechanization raised labor productivity, growing amounts of raw materials must be paid for. One consequence of this is that if the profitability of capital falls, at some point the amount of profit will be inadequate for further expansion of the system. (The General Motors factory in Lordstown, Ohio, then the most automated automobile factory in the world, cost $100 million to build in 1966; in 2002, GM spent $500 million to modernize the plant, which permitted reducing the workforce from 7000 to 2500. Only seven years later, GM is begging for a government handout to avoid going out of business.)

Slowing or stagnant investment means a shrinking market for produced goods. Employers neither invest capital in the purchase of buildings, machinery, and raw materials nor pay the wages which workers would have spent on consumer goods. A slowdown in investment, that is, is experienced by workers as a rise in unemployment and by businessmen as a contraction of markets. This is a self-magnifying process, as declining demand causes business failures, higher unemployment, and further contraction of demand. At the same time, since businessmen (and other borrowers) are increasingly unable to meet financial obligations, the various forms of IOUs issued by banks and brokerage houses become increasingly valueless, causing a financial crisis, while falling stock prices reflect the declining value of business enterprises. Individuals and institutions hoard money, rather than invest it. In short, capitalism finds itself in a depression.

But in a capitalist economy, what causes suffering for individuals can be good for the system. As firms go bankrupt and production goods of all sorts go unsold, the surviving companies can buy up buildings, machinery and raw materials at bargain prices, while land values fall. There is market pressure for the design of new, more efficient and cheaper machinery. As a result, the cost of capital investment declines. At the same time, rising unemployment drives down wages. Capitalists’ costs are thus lower while the labor they employ is more productive than before, as people are made to work harder and on newer equipment. The result is a revival in the rate of profit, which makes possible a new round of investment and therefore an expansion of markets for production goods and consumer goods alike. A depression, that is, is the cure for insufficient profits; it is what makes the next period of prosperity possible, even as that prosperity will in turn generate the conditions for a new depression.

Given this pattern, what is unusual about the current situation is not the decline of profits visible in the global economy in the late 1960s or the serious downturn of the early 1970s, but the fact that a real depression did not materialize until 2008. Like earlier crises, the Great Depression of the 1930s, together with the enormous destructive force of the Second World War, laid the foundations for the new prosperity that came to life in the postwar Golden Age see Part 2: Risky Business. It was not surprising, in view of the history of the business cycle, that this new prosperity began to decline by the end of the 1960s. But if capitalism remained at base the same system, the economic policy practiced by governments had changed. On the one hand, the political dangers threatened by the mass social movements unleashed by the previous depression, as mass unemployment radicalized the population, were unacceptable to the governing elite of the capitalist states, especially in the context of what was believed to be an epic confrontation with Communism. On the other hand, it was also imagined that Keynesian methods of deficit financing could control the ravages of the business cycle. And in fact the continuously growing level of government spending on military and civilian projects after 1945, which increased the demand for goods and services beyond that produced by the capitalist economy proper, created prosperous conditions despite declining profitability.

In addition, the money that governments—the U.S. above all—printed to pay for all this spending, together with the credit private financial establishments were encouraged by central banks to extend to corporate and individual borrowers, made possible the debt expansion that underwrote individual consumption, corporate acquisitions and, especially from the 1980s on, ever more forms of speculation, in real estate, the stock market, and (with the refinement of derivatives) the ups and downs of speculation itself. This ever-increasing public, business, and individual debt appeared on bank and other business balance sheets as profits, despite their missing foundation in real productive enterprise.

Meanwhile, just as in earlier periods of economic decline, pressure was put on workers to work harder, while labor costs were lowered by moving plants from high wage to low wage areas or simply by using the threat of such moves to cut wages and benefits. Starting in the 1980s, spending on the socialized wage payments constituted by welfare-state programs was cut, freeing up money for corporate use. As it was supposed to, all this contributed to an actual increase in profits by lowering production costs, but evidently not by enough, given the costs of production goods, to make possible a new round of capital investment on a scale able to challenge the charms of speculation’s short-run high returns. The result was the economic situation which has arrived so shockingly during the last year, though for several decades the warning signs—debt crises, recessions, bank collapses, stock market failures—were clear enough. Generally ascribed to lax regulation, greed, or bad central-bank policy, the current economic collapse is in line with the whole history of capitalism as a system. What we are faced with today is, more or less, the depression that should have come much earlier, but which political-economic policy was able to delay—in part by displacing it to poor parts of the world, but largely by an historically unprecedented creation of debt in the rich parts—for thirty-odd years.

Now the crisis is here. What form will it take? And what can be done about it? I will turn to these questions in the next (and last) article in this series.

Part 1: Up in Smoke

Part 2: Risky Business