A general explanation of the American business cycle of 1991-2001.

ABSTRACT

This paper examines the American business cycle of 1991-2001 by developing a general explanation grounded in Veblen's theory of the business cycle. The expansionary phase of the business cycle which is the outcome of increased profit margins is explained by various sources, including the low cost of doing business, high investment and consumption expenditures which increased prices and revenues, globalization, and the support of various domestic and international institutions such as the state, the Fed, the IMF, and the World Bank. The recessionary phase, which is explained by the reduction of profit margins, is analyzed by the same sources as they operate in the opposite direction.

Keywords: Productivity, Shocks, Financial Fragility, Globalization, Imperialism, Rising Labor Cost.

1. INTRODUCTION

The last recession in the American economy ended on March 1991. This was followed by an economic expansion which lasted until March 2001, the longest expansion in American history, and then was followed by a short recession after March 2001. Many economists and politicians were disappointed by the new recession, because it was thought that the business cycle had died in the 'new economy' (Weber, 1997 and Zarnowitz, 1998). During the economic expansion unemployment and inflation were on an average of 5.6 and 2.8 percent, respectively, and productivity increased on an average of about 2.3 percent. The inequality in income distribution measured by the Gini coefficient increased from 43 percent in 1990 to 46 percent in 1999. Wages increased by less than one percent relative to 1973, because the economy was able to generate mostly low paying jobs. In addition, the number of poor people was about 32.3 million in 1999, and had not declined significantly during the longest expansion.

This paper develops a general Veblenian explanation of the business cycle, that depends on Veblen's theory of the cycle and on additional causes consistent with that theory. Section 2 is devoted to review some of the important literature of the modern theories of the business cycle, and section 3 develops the general Veblenian explanation of the business cycle, which will be used in sections 4 and 5 to analyze the causes behind the economic expansion and recession of the American economy during 1991-2001. Section 6 is devoted to a summary and conclusions.

2. LITERATURE REVIEW

Modern standard theories of the business cycle are diverse. The real business cycle (Kydland and Prescott 1983 and 1990, Plosser 1989, and Freeman and Kydland, 2000) which is based on micro foundations argues that shocks to aggregate supply such as changes in technology are the driving force for an expansion and contraction. These shocks affect the components of the production function of labor and capital, and spread out, influencing the growth rate of the aggregate output. For example, a positive shock in technological advances increases demand for investments, capital, employment, and income. After the shock, aggregate output grows in a way that does not return to its normal trend which prevailed before the shock, because it grows at a certain growth rate plus a term of the random shock called drift. In other words, output grows at a rate higher or lower than its normal trend.

New Keynesian theory (Hall 1990, Mankiw and Romer 1991, Bernanke and Carey 1996, and Borda etal 2000) argues that the business cycle is generated by the instability of aggregate demand and supply. In the short run, aggregate demand raises both prices and output, but prices increase modestly relative to demand, as mark-up prices and labor cost are not completely flexible (i.e., stickiness of nominal wages). This is due to factors such as contracts, menu cost, and near rationality, which are associated with imperfect markets. As the price level increases due to increased money supply, real wages decline, and employment and output will increase. Positive aggregate supply shocks, generated by a decline in oil prices and improvement in technology, reduce marginal costs and increase the aggregate supply. But negative supply shocks tend to increase marginal cost and reduce aggregate supply, generating an economic downturn. Similarly, a decline in consumption and investment expenditures generate a recession, because as the aggregate demand decreases prices do not decline rapidly. Consequently, real wages will increase, causing a decline in employment and output.

Minsky (1986 and Papadimitriou and Wray, 1999), a great post Keynesian economist whose theory of the business cycle is endogenously determined and is grounded in Keynes's (1936) and Fisher's (1933) works, argues that when demand price of capital is greater than the supply price, investment will increase, and so will earnings and profits. Consequently, firms borrow more funds so that the ratio of total debt to asset (or leverage) will rise. In a boom condition the actual earnings may be even larger than the expected earnings, which simulate firms to borrow money to finance investments. But the boom ends when interest rates increase and investments and revenues will decrease, creating a situation of financial fragility for many firms. This fragility reduces the sources of new loans to finance investments, and many firms are not able to pay their debts; hence, investment ceases and recession appears. (Similarly, Bernanke and Gertler (1990) think that financial fragility or low borrower net worth leads to a complete collapse of investment.)

Many other theories of the business cycle, which are available in the economic literature, provide a cause (a determining mechanism) or causes explaining an expansion and a downturn. Those are alluded to below when the causes of the economic expansion and downturn are discussed. But the explanation developed in the next section provides more general explanation for the business cycle than the modern ones.

3. A GENERAL EXPLANATION OF THE BUSINESS CYCLE

Veblen (1904 and 1923) provides a provocative evolutionary analysis for the theory of the business cycle in a capitalist economy, an analysis explaining the recession and expansion according to the principles of increasing (decreasing) cost and decreasing (increasing) revenue, or decreasing (increasing) profit margins. For an expansion (or prosperity), Veblen suggests various causes for the reduction of the cost of restricted output. He (1923: 97) contends that a "ceaseless advance of the mechanical technology has ... the effect of lowering the production cost of the necessary equipment, as also the (physical) cost at which raw materials may be had." So, a reduction in prices of capital goods and raw materials such as oil generates a lower cost of production for business enterprises.

One of the initial effects of introducing technology is to replace workers and to reduce money wages to keep production-costs down (Veblen, 1923: 220 and 287]. In the same context, Veblen thinks that the business community intends "to buy the industrial man-power as cheap as may be, and to sell the means of living ... as dear as may be" (1923: 200). Mergers and consolidation enable businesses to cut wages and other elements of production cost. Moreover, lower money wages that are associated with increased productivity cut cost of labor per unit of output. This behavior of rising productivity and of paying workers as cheap as may be implies a lower share of labor in the Gross Domestic Product (GDP) and an increase in inequality of income distribution in favor of the business community (or the absentee owners). Later on, Mitchell [1913 and 1951] includes other detailed sources reducing the cost of production such as interests, administrative cost, and the like. In short, Veblen points out: "The earnings of enterprise and invested capital are always eventually to be drawn from the margin of sales-price over production-cost, it is incumbent on all business management to curtail production-cost so far as may be" (Veblen, 1923: 393).

On the revenue side, Veblen correctly argues that the fundamental objective of business enterprises is "to increase their sales without lowering prices" (1923: 287). Salesmanship which consists of advertising and personal bargaining (Veblen, 1923:311) is used to increase sales and revenue of output, which is usually restricted by the captain of finance and by the Fed when it raises interest rates and reduces credits to limit the productive capacity of the economy (Veblen, 1921: 63-70 and 1923: 219f). Debt is needed for generating a higher demand and prices, and so is an increased supply of money (or precious metal according to Veblen). Thus, given low cost, Veblen correctly thinks that profit "is widened by raising the level of sales-price; both by efficient salesmanship in the merchandising trade and by a continued expansion of the outstanding volume of purchasing-power through a continued creation of credit" (1923: 400).

Government, an important institution serving the interest of absentee ownership (Veblen, 1923: 432), enhances "prices by contributing to the security [of the country]" (Veblen, 1923: 400). Veblen (1904: 250-56 and 1923: 34-5 and 398-411) thinks that security is maintained by spending on police and military; both of these wasteful expenditures generate a high aggregate demand that enhances prices and revenues. In addition, revenues can be increased by both merger and consolidation to reduce competition (1904: 240-44 and 1923: 337] and by enlargement of domestic and foreign markets (Veblen, 1923: 287), where the latter is achieved by imperialism (or globalization). In short, prosperity comes by increasing revenues and decreasing costs, a situation called by Sherman (1991 and 1996) a nutcracker whose two sides open (close) when profits are high (low) during the expansionary (recessionary) phase of the business cycle. For Veblen, high profits explaining the internal dynamics of prosperity mean higher earnings and capitalization, as business enterprises issue more outstanding securities. The result is that some of these enterprises become over-capitalized (1904: 220-21 and 1923:182-83, 221f and 334). In contrast, if the elements of cost such as wages (and a reduction in labor productivity) increase and revenue declines (e.g., due to technology which increases production and cut prices), the nutcracker closes its two sides, squeezing profits and earnings, and generating financial problems (fragility) for some business enterprises, as they have to pay the fixed charges for the means of debt created during the expansion; hence, a liquidation process and a recession will follow.

There are several justifications for choosing this Veblenian explanation for the recent American business cycle. First, it is based on the microfoundations of macroeconomics, and considers the American economy mostly as an economy dominated by large corporations aiming at making profit margins. In this economy, the financial magna and the Fed control finance, interest rates, and credits; hence, they influence the productive capacity of the economy, as well as employment and the business cycle. Second, the Veblenian explanation is more general than the existing models of the business cycle, for it takes into consideration all variables and institutions (economic, political, technological, imperialism, and the like) affecting revenues and costs and consequently profit margins. In other words, it analyzes the business cycle endogenously and exogenously as complementary sides of the dynamics of capitalism. For example, an oil embargo, as a shock, generates a higher price of oil, which increases the cost of production and reduces revenues and profits, affecting an economic expansion negatively. Globalization (or imperialism) is also useful for finding markets for products and places for obtaining economic resources, as well as profitable investment opportunities.

4. THE BASIC CAUSES OF THE EXPANSION

There are various important causes explaining the economic expansion which is the outcome of increasing revenue and decreasing cost, or increasing profit margins. The first cause was consumption expenditures. Although disposable income had not increased significantly for the middle and lower social groups, consumption expenditures were increasing over the years. Economists [such as Friedman (1957) and Ando and Modigliani (1963)] argued that the wealth effect was a driving force behind these increased expenditures. Many stock holders suggested that their consumption expenditures increased because of high income generated by the increased value of stocks: the wealth effect. Although this is partially true it may not be so decisive. On the one hand, stock holders from the middle class did not own a large volume of stocks; thus, they could not realize a large value of capital gains when the value of stocks increased. On the other hand, wealthy people, who received capital gains, may spend a limited amount of income on conspicuous consumption, as the increases in their income were usually directed towards more savings for status and power (Carroll, 2000). Duca (2001:16) points out, "One concern about the importance of stock market wealth is that stock ownership is concentrated among the very rich, whose consumption is probably not affected much by swings in stock prices.... In particular, evidence reveals that the rich save partly to acquire and preserve ... power and status ... These concerns imply that the stock market wealth effect will be very limited." Therefore, it is safe to state that consumer spending of various social groups but the very wealthy must have come from other sources such as the huge amount of debt. Table 1 shows consumer debt and the ratio of debt to disposable income over some years of the economic expansion.

As the data suggest, consumer debt increased from 3.5 trillion dollars in 1990 to about 6.5 trillion dollars in 1999, and this trend continued during 2000. Also, the ratio of debt to disposable income increased from 82.8 percent in 1990 to 97.4 percent in 1999. Similarly, the growth rate of private consumption expenditures increased from 1.8 percent in 1990 to 5.3 in 1999. By the same token, total consumer credit outstanding, which covers most short and intermediate term credit extended to individuals excluding credit by real estate, was increasing since 1990. In that year it was $805 million and rose to $1,426 million in 1999. These increases in debt (or credits), obtained by low and middle classes, provided a significant force for increasing consumption expenditures on durable and nondurable goods and services over the economic expansion. In Veblen's language, these expenditures, generated by extending credits, increased demand, prices, and revenues. [The interpretation of this fact support the old theory of under-consumption of the business cycle. See Bleany (1976), Sweezy (1942), Sweezy and Magdoff (1978 and 1974), Devine (1987), Pollin (1988a and 1988b), and Foster (1987)].

In addition, there is no doubt that mortgage refinancing contributed significantly to increased consumer spending. Refinancing mortgages at lower mortgage rates generated extra income for most middle classes, an income which could be spent in part on consumption. Moreover, financial institutions had come out with new home-equity loan strategy to put more income in the hands of people to spend on consumption. Rather than obtaining loans with no deductible interests, some people used home equity loans to pay their debts and used the rest to spend on consumption with tax deductible interests. (All types of loans such as student loans, auto loans, and furniture loans created a push for consumption.)

The second cause of the economic expansion was the increase in gross private domestic investments. Table 2 shows the growth of various types of investments during the 1990s.

Investments were stimulated for a variety of reasons during the economic expansion of the 1990s, such as low interest rates, optimistic business expectations about future revenue and cost, low cost of production including low taxes and wages, technological innovations, population growth, public economic policies and political condition. Innovations in information technology caused a sequence of investments in computer, Internet, cellular phone, software, and other important electronic equipment and tools, which will produce significant causes and effects for many variables over the coming years. In other words, the diffusion of innovations generated more investments. This trend in favor of investments can be observed by the high growth rate of investment in information technology relative to business investment. This ratio (not shown) increased from 27 percent in 1990 to about 39 percent in 2000, implying that computers and microchips were producing higher profits and rapid productivity growth (see Table 3), which in turn increased investments and profits again. For Veblen (1904 and 1914), the process of technological innovations continues for years and can even change the entire economic system if it is not impeded by particular institutions.

Various computer firms were established and a variety of software was developed. Individuals took advantage of this process of innovations by a simple process of start-ups and public offerings whose consequences were many new products. Also, these innovations forced many firms to use (or copy) the new technology in order to compete through cost reduction, high efficiency, and high quality of output, and by the year 2000 the private sector in the United States spent about $200 billion on Research and Development (R&D). All these sources generated a high profit share for capital, as shown in Table 4. [This argument supports Marx's theory of capital accumulation in that capitalists have to invest in order to expand business; hence, he considers capital accumulation as the independent variable. Also, this explanation should support Marx's theory of profit rate. This rate is equal to the surplus value (S) divided by the sum of fixed (C) and variable capital (V). Due to technological advances and innovations, the prices of physical means of production decline. Consequently, the rate of profit, ceteris paribus, increases. Moreover, the argument is consistent with Schumpeter's theory of the business cycle, in which innovations generate development and boom, as well as entrepreneurial profits. See Schumpeter (1939), Kalecki (1966), and Laibman (1987) An important implication is that if technological innovations during an expansionary period are labor-saving, then profits will be increasing due to high productivity and low wages, and employment may not rise or even decline. This economic condition creates what has been termed a jobless recovery].

These investment expenditures generated a maximum rate of capacity utilization of about 82 percent. The unused (idle) productive capacity was the basic reason why demand for labor and investments did not increase as they should have. The overcapacity of the physical means of production along with an overcapacity in the human means of production created a tendency toward stagnation in American capitalism. It also explains the fact that the ratio of the total fixed domestic investment in the Gross Domestic Product, I/GDP, was about 15 percent over the economic expansion.

It should be indicated that foreign capital, which flowed to America because of high returns and political stability, did contribute to the U.S. gross private domestic investments. The net foreign investment as a percentage of the U.S. gross domestic private investments was about 4 percent in 1990 and rose to 23 percent in 2000, signifying that about 22 percent of the U.S. gross private domestic investments were funded by foreign investments. In other words, the globalized world economy, as will be shown below, provided an important source of savings for the U.S. economy.

The most important institution, besides the government, that helped the American economy expanding over the 1990s was the Federal Reserve Bank (Fed). Normally, the Fed controls the economy by raising (or decreasing) the Federal funds rate to slow down (or expand) the productive capacity: employment and investments (Veblen, 1921 and 1923). The Fed watches the ratio of wages (and benefits) to productivity in order to increase or decrease the Federal funds rate. This ratio decreases further due to a slowdown in wages and benefits or to an increase in labor productivity or both, a condition associated with a rise in the share of capital. When this happens the Fed cuts the Federal funds rate to reduce the cost of money in order to increase consumption and investment expenditures, prices, and revenues. The Fed did use this policy when it cut the Federal funds rate 17 times between October 1990 (when it was 7.75 percent) and September 1992 (when it was 3 percent) in order to stimulate the economy after the recession of March 1991.

The third important cause generating the economic expansion, a cause which had been overlooked, was militarism (Veblen, 1904). The beginning of the 1990s was a time for strengthening the military capability of the United States to achieve the global objective of controlling some of the world economic resources and foreign markets. Also, the American economy depended on militarism and on small regional wars, which contributed to the economic expansion. The Gulf War was an excellent option for the Bush administration, because the American forces were stationed very close to the oil fields. The military spending before and after the Gulf War fueled the defense industry and hence the U.S. economy. The government had to increase spending on weapons, tanks, cars, bombs, uniforms to protect soldiers against chemical weapons, and the like. All these expenditures helped the American economy to generate high prices, revenues, and profits. Even when the Gulf War was over, the American forces remained stationed in close areas in order to bomb Iraq continuously. This means that the U.S. government had to spend more on weapons and other military means. (This spending may have been financed by Saudi Arabia.) After the last intensive bombing of Iraq the Pentagon announced that the inventory level of missiles had declined to its minimum, which had to be replenished with government spending. In addition, the Gulf War provided an excellent opportunity for the U.S. to control the Middle East and its oil. This in turn generated super profits to American oil corporations and accommodated the military industry with markets to sell American weapons to some of these oil countries such as Saudi Arabia and the UAE.

The Clinton Administration provided various means of support to American capital to dominate the world. These means were low taxes on capital; approval of corporate mergers; the fiscal restraint which allowed the monetary policy to achieve its targets; and the means to convince workers that higher wages and benefits did create inflation and recessions. In short, the government played a significant role in expanding the process of capital accumulation and the economy for the benefits of the vested interests and the absentee owners. After the Gulf War the U.S. continued its military activities in Kosova. The Pentagon bombed Serbia for more than six weeks, and created a high demand for military products. There were other cases of military operations where the United States government was involved such as the war in Somalia and the military support against the uprising in East Timor. As it happened during the Gulf War, the inventory of weapons declined and the government had to spend to keep the standard inventory of weapons. In short, militarism revived the defense industry. [This analysis supports Keynes's argument that militarism does expand the capitalist economy. Also, see Marx and Engels (1974 and 1992), Luxemburg (1968), Baran (1957), Baran and Sweezy (1966), Magdoff (1982), Cypher (1972), and Foster (1987)].

Globalization is the fourth factor causing the economic expansion of the American economy. Globalization provided markets for the American products, cheap inputs such as oil, savings, and inexpensive educated workers who came from India, Pakistan, and other countries. Several arguments have been made that without foreign workers (immigrants, foreign students in American universities, and foreign workers) who specialize in information technology, the American economy would never have expanded the way it did. In addition, globalization contributed to the economic expansion in different ways. During the expansion some important Asian economies slid into recessions whose basic consequence was low prices of raw materials and other commodities, which lowered the inflation rate in the U.S. economy and reduced the cost of doing business. Eventually, these lower prices, along with technological innovations, led to increased profitability for American firms and fueled the economic expansion.

The institutions of International Monetary Fund (IMF) and the World Bank (WB) provided significant contributions to the American economic expansion. During the 1990s these two institutions, with the support of the United States government, developed several structural adjustment programs to facilitate the process of economic development in developing countries. These policies were privatization of public enterprises, reduction of government expenditures on social programs and augmentation of interest rates, elimination of restrictions on international trade and foreign investments (portfolio and direct), reduction of prices of exported commodities, and devaluation of national currencies. Within this framework, if any developing country was in need of a loan from an international bank, the loan might be approved if the country adopted these contractionary policies. Many developing countries, such as Mexico, Argentina, Brazil, South Korea and Thailand, to mention a few, needed loans from international banks and markets to sell their products, a need that forced these countries to adopt these policies whose basic outcome was the appearance of several economic crises in these countries during the 1990s [see Bello and Cunningham (1994) and Crotty and Dymski (1998)].

On the IMF and the World Bank, Magdoff (1993: 4) correctly states:

   The IMF and the World Bank continue to function as protectors of
   the imperialist system, acting as the enforcers for core
   capitalism: to make the periphery behave as supplier of raw
   materials, provide opportunities for investment and trade, and
   last, but not least, to make sure that the debts to the bankers
   in the money centers are properly served.

Similarly, the World Trade Organization (WTO) supported the same program of austerity in the developing countries and compelled these countries to accept foreign corporations to operate and to own properties in these countries in exchange for loans and markets for their low-price commodities and primary inputs. This was done for the cause of free global trade, and the eventuality of these programs was a reduction in real wages in the advanced countries and the use of child labor, exploitation of economic resources, and higher unemployment in developing countries.

Policies of these international institutions, which integrated the developing countries to the advanced capitalist countries, provided a momentum for the American expansion. The provision of funds for these countries produced more interest payments for financial corporations, which were converted into private domestic investments in the United States and the rest of the world. The importation of raw materials and finished commodities from these countries provided the United States with low cost materials for industrial use and low prices of commodities that could control inflation. It was also estimated that some American banks, with the help of the previous policies, obtained about one trillion dollars during the last decade through money laundering, whose sources were crimes, drugs, and political crimes in the developing countries (Petras, 2001: 11). These funds could be used as a complementary source for the weak American saving rate.

The fifth significant cause behind the economic expansion was the reduction in labor cost per unit of output. This ratio is obtained by dividing money wages by labor productivity. As productivity growth was increasing faster than the stagnant wages, the ratio was decreasing, and so was the labor share in the Gross Domestic Product (GDP). Simply stated, capital share (profit) was increasing, and the economic expansion was accelerating. Table 3 shows labor cost per unit of output and productivity during the years of the expansion.

As the table shows, the growth of labor cost was 4.4 in 1990 and declined to about 1.8 percent in 1999. In some years such as 1996 the percentage change was 0.4 of one percent, which was the lowest growth over the expansion, and productivity was increasing, a trend that contributed to increased capital share: profit. The table also shows that nonfinancial corporate profit was growing but declined during 1998-99. In short, the growth of money wages lagged behind the growth rate in productivity. Strobel and Peterson (1999: 54) argue that "real wages in the United States, as measured by average weekly earnings, fell from $315.44 at the postwar peak in 1973 to $260.89 in December 1997, using inflation adjusted dollars."

The fact remains that the economic expansion was generated by squeezing labor income share: wages and the essential factors in this squeeze were the increases in productivity and the weakness of unions. [This analysis supports Marx's contention that technology saves labor and increases profits. [See also Sherman (1991), Sherman and Kolk (1996), Boddy and Crotty (1975), and Glyn and Sutcliffe (1972)]. Various other reasons can be provided for explaining the slowdown in wages (or unit labor cost). Firms were replacing labor by machines, a process that was associated with spending less wages as a result of corporate downsizing. Some firms were also moving their locations of production to other countries with lower wages, more productive labor, less government regulations, and very weak labor unions. Firms were using this capital movement as a threat if American workers demanded higher wages and benefits. Moreover, structural changes in the U.S. economy such as the shift from manufacturing to service industries was a process associated with degradation of skills and lower wages and benefits. The outcome of increased productivity and decreased wages is the shift in income distribution toward the wealthy, a point that will be discussed in the next section.

5. THE CAUSES OF THE RECESSION

Before the end of 1999 various forces operated in the American economy, generating a new recession in March 2001. Some of these forces led to a slow down in effective demand such as the reduction in consumption and investment expenditures which reduced prices and revenues, and other forces generated increases in the cost of doing business that usually reduced the aggregate supply. With respect to the increased cost of doing business, several factors contributed to that increase. The first factor was the increase in labor compensation. As a central aspect of the process of capital accumulation, when demand for labor increased during the second phase of the economic expansion, money wages rose. Although the increase in the growth rate of labor compensation was not very rapid, it did erode profitability.

Table 4 shows that labor compensation was growing since the second quarter of 2000 at an average of about 3 percent. This growth rate could have been higher without the availability of foreign workers who were employed in information technology and who contributed to the expansionary phase of the business cycle. But the increase in this variable inflicts damage to profit when labor productivity does not increase at the same pace (or at a faster rate). What makes producers nervous about the increased labor compensation is the slowdown in labor productivity. Indeed, the output per worker per hour in the nonfinancial sector was growing by about 1.6 percent or even lower in 2000 and 2001. Combining the increased labor compensation with the slowdown in labor productivity, it can be concluded that the labor cost per unit of output was increasing over these two years. Table 4 shows that the labor cost per unit of output was increasing from 0.666 in 1999 to about 0.70 in the second quarter of 2001. Consequently, the profit per unit of output (or profit margin) was declining. In fact, the profit per unit of output in the nonfinancial sector declined to 0.08 in the second quarter of 2001, which was the lowest profit margin since 1993.

The increased cost of doing business was brought about by an additional two fundamental factors. The first factor was the increased cost of energy, particularly the price of crude oil. The price per barrel of crude oil rose from $12.00 in 1999 to about $32.00 on December of the same year. The high price of oil continued till the first week of September 2001, then declined to about $22.00 after the end of September 2001. Many arguments were proposed suggesting that the American economy could not be affected by the high price of oil, for the economy was adjusted to absorb oil shocks, as a result of the usage of advanced technology which required less oil. But the reality turned out to be different. The high price of oil had increased the cost of production of many industries using oil as a basic input (such as the airline industry). Once these industries' profits were affected negatively, other related industries suffered, culminating in a slowdown in economic activity. In addition, on the average an American spent annually about $1500 on oil, and the high cost of oil absorbed a reasonable percentage of consumer's income, which deprived other industries from obtaining advantages of consumers' spending. In other words, demand for oil is inelastic, and when the price of oil goes up, total expenditures on oil will mount. Therefore, the only beneficiary of high oil prices were foreign oil producers and American oil corporations, and both generated super profits and the economic downturn. [For an analysis of the role of oil in generating previous recessions in the American economy see Hamilton (1983), and Hoover and Perez (1994)].

The second factor which led to the increased cost of doing business was the high interest rates engineered by the Fed (Veblen, 1921 and 1923). The Fed increased the Federal funds rate to 5.25 percent in August 1999, and the movement continued after the Fed raised the Federal funds rate to 5.5, 5.75, 6.0, and 6.5 percent during November 1999, February 2000, March 2000, and May 2000, respectively. This was engineered to keep attracting foreign savings and to control employment and wages rather than inflation rate, as Romer (1999) argued. But these increases which were associated with technological innovations were able to produce a deflationary trend in prices which reduced revenues. They also generated financial bankruptcies and inflicted damages to technology, auto, and housing sectors, because these sectors were very sensitive to interest rates. The Fed should not have raised the Federal funds rates, because the law rate of unemployment did not produce high wages to workers as shown in Table 3. But the Fed did reduce the Federal funds rate from 6.5 to 6 percent in January 2001, which was too late anyway, because at that time the economy was already in slump. In short, the Fed sabotaged the economy when it increased the Federal funds rate in 1999.

Once the profit per unit of output (expected and actual) declined due to the increased cost of doing business and to the decreased revenues, the incentive for capital spending (demand for investments) eroded. Investments in computer technology, communication tools, software, and other means of increasing productivity were declining sharply as shown in Table 5.

The Table shows that the growth rate of private domestic investments declined from 6.8 percent in 2000 to (-12.3) percent in the second quarter of 2001. The basic components of investment, which are the structure and equipment and software, declined by (-13.4) and (-15.1) percent, respectively. These negative growth rates provided a very important cause for the new recession. This is because these decreases indicated not only low profit margins but also the existence of an overcapacity, whose eventual outcomes were lower employment, income, prices, and revenues. Also, the investment decline in structure and equipment and software had another important effect, in that it reduced labor productivity and capital deepening, which increased labor cost per unit of output and reduced revenues and profit margins. Thus, it is not a surprise to find that the negative growth rate in gross domestic private investment tended to generate a lower growth rate in (GDP), which was 0.2 percent in the second quarter of 2001. In addition, the decline in the growth rate of GDP reduced employment and personal income, which in turn reduced consumption and investment expenditures, as well as prices, revenues, and profit margins.

Besides the existence of overcapacity and high interest rates, there was another basic reason behind the decline in investment expenditures. The increased level of inventory of the means of production created by the existence of overcapacity and the slowdown in business spending prevented firms from producing and investing at rapid rates. Firms producing means of production were filling demand for their goods by reducing their inventory level rather than production. This in turn created stagnation in the production process, which reduced the rate of capacity utilization of the manufacturing sector to about 78.4 percent in 2001: the lowest rate over the last 18 years. That is to say, when the existing capacity was not utilized fully, investments did not increase.

Another reason behind the recession was the slow growth of consumer spending, which was about 2.5 percent in 2001 (see Table 5). Several reasons explained this slowdown in consumer spending. First, the rate of growth of consumer borrowing was declining, as outstanding consumer credit declined from $1.566 trillion in 2000 to about $1.558 trillion in the first quarter of 2001. Table 5 shows that the growth rate of consumer credit outstanding declined from 9.8 percent (relative to 1995) in 2000 to negative 0.5 of one percent in the first quarter of 2001. Second, the twenty percent decline in the stock market created a negative wealth effect which reduced wealth and consumption of the middle class' stock holders. In addition, some of the middle class holders of money market certificates were used to obtain about 6 percent of annual interest rate, and when the interest rates declined to less than one percent in 2001, consumption spending declined as well. Third, the rate of unemployment increased to about 5 percent, which reduced income, the growth of consumption expenditures, and prices. Fourth, there was an increase in the inequality of income distribution, and data showed that the top 20 percent of the population received about fifty percent of the national income, and the other 80 percent of the population received the other fifty percent of income. The Gini coefficient (see Table 4) was about 46 percent in 2000, compared to 36 and 43 percent in 1973 and 1994, respectively; which was the highest value in the history of the United States of America. The distributed income suggested that the wealthy groups who received the largest share of income were spending a lower portion of their additional income on consumption. Moreover, inequality in income distribution reduced consumption, because people with lower income could not purchase some of the items they needed. As this inequality increased, it contributed to the slowdown in consumption expenditure.

6. SUMMARY AND CONCLUSIONS

In this paper a Veblenian explanation of the recent American business cycle is provided. This explanation contends that the differential (profit margins) advantage between increased revenues and decreased costs is the driving force for the business cycle. If the differential advantage increases, prosperity continues; if it decreases a recession appears. Veblen outlines factors that increase business revenues such as increased money supply, militarism, consolidation of firms, increased debt, higher prices, government spending, imperialism (or globalization), and the like. Factors that cut cost of doing business are improved technology (or the state of industrial arts), increased labor productivity, decreased wages and interests, and cheap prices of raw materials.

The revolution of information technology increased the economy's productivity and helped companies to cut production cost. Law paying jobs were created for many people, and higher paying jobs were created for the few. As a whole, increased profits and productivity, lower labor compensation, moderate investment spending, and high growth rates of consumer spending and debt generated the initial impulse for the economic expansion of the 1990s. This impulse was reinforced by the use of global economic resources, commodities, and markets. Globalization required military forces and technology to meet challenges. Militarily, the Gulf War was the starting point, which was followed by the war in Serbia. These two regional wars established the essential footing for America to control strategic parts of the world: the Balkans and the Middle East whose oil reserves are indispensable for American capitalism: super profits for oil corporations and means of global hegemony.

But the increased cost of doing business produced by higher oil prices, interest rates, and labor compensation relative to productivity did reduce profit margins and demand for investments. Consumption expenditure was growing slowly, which is explained by the decline in loans and by the increased inequality in income distribution. The totality of these forces, along with the technological innovations which increased production, produced a deflationary trend in prices and reduced revenues, generating the recession of March 2001.

REFERENCES

Ando, Albert and Modigliani, Franco, "The "Life Cycle" Hypothesis of Saving: Aggregate Implications and Tests", The American Economic Review, Vol. 53 (1), 1963, 55-84.

Baran, Paul, The Political Economy of Growth, Monthly Review Press, New York, 1957.

Baran, P. and Sweezy, P., Monopoly Capital Monthly Review Press, New York, 1966.

Bello, Walden and Shea Cunningham, Shea, Dark Victory, the U.S., Structural Adjustment, and Global Poverty, Food Fast, London, 1994.

Bernanke, Ben and Gertler, Mark, "Financial Fragility and Economic Performance", The Quarterly Journal of Economics, Vol. 105 (1), 1990, 87-114.

Bernanke, Ben and Carey, Kevin, "Nominal Wage Stickiness And Aggregate Supply In the Great Depression", The Quarterly Journal of Economics, Vol. 111 (3), 1996, 853-83.

Bleany, Michael, Under-consumption Theories, International Publishers, New York, 1976.

Boddy, Raford and Crotty, James, "Class Conflict and Macro-Policy: The Political Business Cycle", Review of Radical Political Economic, Vol. 7, 1975, 1-19.

Bordo, Michael D., Erceg, C.J., and Evans, C.L., "Money, Sticky Wages, and the Great Depression", The American Economic Review, Vol. 90 (5), 2000, 1447-1463.

Carroll, Christopher D., "Why Do The Rich Save So Much?," In Joel B. Slemrod (ed.) Does Atlas Shrug? The Economic Consequences of Taxing the Rich, Harvard University Press, Cambridge, Mass., 2000.

Crotty, James and Dymski, Gary, "Can The Korean Labor Movement Defeat the I.M.F.?", Dollar and Sense, 220, 1988, 16-20.

Cypher, James, "Military Expenditures and the Performance of the Post-war Economy, 1947-1971 ." Ph.D. Dissertation, University of California: Riverside, CA., 1972.

Devine, J., "An Introduction to Radical Theories of Economic Crisis", In Robert Cherry etal. The Imperiled Economy, Book I: Macroeconomics From a Left Perspective, URPE, New York, 1987.

Duca, John V., "The Democratization of America's Capital Markets", Economic and Financial Review, Federal Reserve Bank of Dallas, Q2, 2001, 10-19.

Fisher, Irving, "The Debt-Deflation Theory of Great Depressions", Econometrica, Vol 1 (4), 1933, 337-57.

Foster, J.B., "What is Stagnation?", In Robert Cherry etal. The Imperiled Economy, Book I: Macroeconomics From a Left Perspective, URPE, New York, 1987.

Freeman, Scott and Kydland, F.E., "Monetary Aggregates and Output", The American Economic Review, Vol. 90 (5), 2000, 1125-1135.

Friedman, Milton, A Theory of Consumption Function, Princeton University Press, Princeton, N.J., 1957.

Glyn, Andrew and Sutcliffe, Bob, British Capitalism, Workers and Profit Squeeze, Penguin: London, 1972.

Grabel, Ilene, "Neoliberal Finance in the Developing World", Monthly Review, Vol. 51, (11), 2002, 34-46.

Hall, Thomas E., Business Cycles: The Nature and Causes of Economic Fluctuations, Praeger, New York, 1990.

Hamilton, James D., "Oil and the Macroeconomy Since World War II", Journal of Political Economy, Vol. 91 (2), 1983, 224-248.

Kalecki, M., Studies In the Theory of Business Cycles: 1933-1939, Kelley, New York, 1966.

Keynes, J. M., The General Theo of Employment Interest and Money, Harcourt Brace Jovanovich, New York, 1936.

Kydland, Finn E. and Prescott, Edward C., "Time to Build and Aggregate Fluctuations", Econometrica, Vol. 50 (6), 1982, 1345-1370.

Kydland, Finn E. and Prescott, Edward C., "Business Cycles: Real Facts and a Monetary Myth", Quarterly Review, Federal Reserve Bank of Minneapolis, Vol. 14 (2),1990, 3-18.

Laibman, D., "Technical Change and the Contradictions of Capitalism", In Robert Cherry etal. The Imperiled Economy, Book I: Macroeconomics From a Left Perspective, URPE, New York, 1987.

Luxemburg, Rosa, The Accumulation of Capital, Monthly Review Press, New York, 1968.

Magdoff, Harry, "What Is The Meaning of Imperialism?", Monthly Review, Vol. 45 (4), 1993, 1-7.

Magdoff, Harry, "International Economic Distress and the Third World", Monthly Review, Vol. 33 (11), 1982, 1-13.

Mankiw, N.G. and Romer, D., New Kenyesian Economics, MIT Press, Cambridge, Mass., 1991.

Marx, K., Capital, Three Volumes, International Publishers, New York, 1967.

Marx, K. and Engels, F., On Colonialism, Progress Publishers, Moscow, 1974.

Marx, K. And Engels, F., The Communist Manifesto, Bantam, New York, 1992.

Minsky, H., Stabilizing an Unstable Economy, Yale University Press, New Haven, 1986.

Mitchell, W., Business Cycles, University Of California Press, Berkeley, CA., 1913.

Mitchell, W., What Happens During Business Cycles, NBER, New York, 1951.

Papadimitrio, D.B. and Wray, R., "Minsky's Analysis of Financial Capitalism," Working Paper No. 275, The Jerome Levy Economics Institute, Annandale-on-Hudson, 1999.

Petras, James, "U.S. Banks And the Dirty Money Empire", Dollar and Sense, 237, 2001, 11-13.

Plosser, Charles I., "Understanding Real Business Cycles", Journal of Economic Perspectives, Vol. 3 (3), 1989, 51-77.

Pollin, Robert, "Deeper in Debt: The Changing Financial Conditions of U.S. Households", Report prepared for Joint Economic Committee, U.S. Congress, Washington, D.C., 1988a.

Pollin, R., "The Growth of U.S. Household Debt: Demand-side Influences", Journal of Macroeconomics, Vol. 10 (2), 1988b, 231-248.

Romer, Christina D., "Changes in Business Cycles: Evidence and Explanations", Journal of Economic Perspectives, Vol. 13 (2), 1999, 23-44.

Schmitt-Grohe', Stephanie, "Endogenous Business Cycle and the Dynamics of Output, Hours, and Consumption", The American Economic Review, Vol. 90 (5), 2000, 1136-1159.

Schumpeter, J., Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, McGraw-Hill, New York, 1939.

Sherman, H, The Business Cycle: Growth and Crisis Under Capitalism, Princeton University Press, Princeton, NJ., 1991.

Sherman, H., and Kolk, D., Business Cycles and Forecasting, Harper, New York, 1996.

Strobel, F. and Peterson, W., The Coming. Class War And How To Avoid It, Sharpe, New York, 1999.

Sweezy, Paul, Theory of Capitalist Development, Monthly Review Press, New York, 1942.

Sweezy, P. and Harry Magdoff, "Debt and the Business Cycle", Monthly Review, Vol. 30 (2), 1978, 1-12.

Veblen, T., The Theory_ of Business Enterprise, Kelley, New York, 1904.

Veblen, T., The Instict of Workmanship, Macmillan, London, 1914.

Veblen, T., The Engineers and the Price System, Transaction Books, London, 1921.

Veblen, T., Absentee Ownership And Business Enterprise In Recent Times: The Case of America, Kelley, New York, 1923.

Weber, S., "The End of the Business Cycles?", Foreign Affairs, Vol. 76 (4). 1997, 65-82.

Zarnowitz, V. "Has the Business Cycle Been Abolished?", Business Economics, Vol. 33 (4), 1998, 39-45.

Adil H. Mouhammed, University of Illinois at Springfield, Springfield, Illinois, USA

Dr. Adil H. Mouhammed earned his Ph.D. at the University of Nebraska, Lincoln in 1985. Currently he is an associated professor of economics at the University of Illinois at Springfield.

TABLE 1
CONSUMER DEBT AND DEBT/DISPOSABLE INCOME

                                            Growth of
                                            Personal       Consumer
                                          Consumption *     Credit
       Consumer Debt   Debt/Disposable    Expenditures    Outstanding
Year   (Billions) **   Income (Percent)     (Percent)     (Billions)

1990      3554.3             82.8              1.8           805.10
1995      4782.9             88.2              3.0          1122.80
1999      6469.1             97.4              5.3          1426.20

Source: * www.bea.doc.gov/bea/newsrel/gdp300a.htm

** This includes household home mortgage and consumer credit

** Source: www.bog.frb.us/releases/z1/current/(September 15, 2000).

TABLE 2

PERCENTAGE CHANGES IN REAL GROSS PRIVATE DOMESTIC INVESTMENT

                        Equipment and
Year    Structures         Software        Residential

1990         1.5              0.4              -8.6
1991       -11.0             -2.0             -12.8
1992        -6.0              7.4              16.3
1995         4.8             11.5              -3.6
1997         8.5             15.8               2.3
1999        -2.8             12.0               7.2

Source: Economic Report of the President (2000), p.311.

TABLE 3
PERCENTAGE CHANGE IN UNIT LABOR COST AND PRODUCTIVITY, 1992 = 100

                                        Wage Growth
                                      (Average Hourly     Growth of
        Unit Labor                     (Compensation     Nonfinancial
Year       Cost       Productivity       Per Hour)          Profit

1990       4.3             1.4              0.5
1991       3.3            -0.9              1.1               1.0
1992       1.2             3.9              2.7              -0.6
1993       2.1             3.0             -0.4              34.0
1994       0.8             4.7             -0.1              22.3
1995       1.1             3.4             -0.6               9.4
1996       0.4             4.4              0.4              14.7
1997       1.6             5.3              1.4              10.3
1998       2.4             5.2              3.8              0.12
1999       1.8             4.2              2.1               0.7

Source: Economic Report of the President 2000, p.363

TABLE 4
LABOR COMPENSATION, PRODUCTIVITY, UNIT LABOR COST, AND PROFIT

Year                   1999      2000      II00      III00

Real Hourly Labor
Compensation           2.3       1.4       5.0       3.1
Labor Productivity     3.0       4.0       7.1       4.0
Unit Labor Cost        0.666     0.667     0.672     0.676
Unit Profit            0.108     0.105     0.111     0.108

Year                   IV00      I2001     II2001

Real Hourly Labor
Compensation           6.5       1.5       3.0
Labor Productivity     1.6       0.6       2.8
Unit Labor Cost        0.689     0.698     0.704
Unit Profit            0.098     0.088     0.084

Source: BEA/New Release/Nonfinancial Corporations
BEA/Quarterly Labor Productivity

TABLE 5
SOME MACROECONOMIC INDICATORS

Year                    1999    2000    III00   IV00    I01    II01

GDP Growth              4.1      4.1      1.3    1.9     1.3     0.2
Gross Domestic
Private Investment      6.6      6.8     -2.8   -2.3   -12.3   -12.3
Structure              -2.0      6.2     15.2    7.6    12.3   -13.4
Equipment & Software   11.8     11.1      4.7   -1.1    -4.1   -15.1
Residential             6.7      0.8    -10.4   -1.1     8.5     5.8
Personal Consumption    5.0      4.8      4.3    3.1     3.0     2.5
Consumer Credit                  9.8                    -0.5     1.4
  Outstanding Growth
Gini Coefficient        0.457    0.46

Source: Commerce Department/BEA/New Release / 29 August 2001