Underconsumption is a theory in economics that recessions and stagnation arise from an inadequate consumer demand, relative to the amount produced. In other words, there is a problem of overproduction and overinvestment during a demand crisis. The theory formed the basis for the development of Keynesian economics and the theory of aggregate demand after the 1930s.
Underconsumption theory narrowly refers to heterodox economists in Britain in the 19th century, particularly from 1815 onwards, who advanced the theory of underconsumption and rejected classical economics in the form of Ricardian economics. The economists did not form a unified school, and their theories were rejected by mainstream economics of the time.
Underconsumption is an old concept in economics that goes back to the 1598 French mercantilist text Les Trésors et richesses pour mettre l'Estat en splendeur (The Treasures and riches to put the State in splendor) by Barthélemy de Laffemas, if not earlier. [1] The concept of underconsumption had been used repeatedly as part of the criticism of Say's Law until underconsumption theory was largely replaced by Keynesian economics which points to a more complete explanation of the failure of aggregate demand to attain potential output, i.e., the level of production corresponding to full employment.
One of the early underconsumption theories says that because workers are paid a wage less than they produce, they cannot buy back as much as they produce. Thus, there will always be inadequate demand for the product.
In his book Underconsumption Theories from 1976, Michael Bleaney defined two main elements of classical (pre-Keynesian) underconsumption theory. First, the only source of recessions, stagnation, and other aggregate demand failures was inadequate consumer demand. Second, a capitalist economy tends toward a state of persistent depression because of this. Thus, underconsumption is not seen as part of business cycles as much as (perhaps) the general economic environment in which they occur. Compare to the tendency of the rate of profit to fall, which has a similar belief in stagnation as the natural (stable) state, but which is otherwise distinct and in critical opposition to underconsumption theory.
Modern Keynesian economics has largely superseded underconsumption theories. Falling consumer demand need not cause a recession, since other parts of aggregate demand may rise to counteract this effect. These other elements are private fixed investment in factories, machines, and housing, government purchases of goods and services, and exports (net of imports). Further, few economists believe that persistent stagnation is the normal state toward which a capitalist economy tends. But it is possible in Keynesian economics that falling consumption (say, due to low and falling real wages) can cause a recession or deepening stagnation.
The case is frequently made that Marx's position towards underconsumption is ambivalent. On the one hand, he wrote that "the last cause of all real crises always remains the poverty and restricted consumption of the masses as compared to the tendency of capitalist production to develop the productive forces in such a way that only the absolute power of consumption of the entire society would be their limit." [2]
However, in Volume II of Das Kapital, he provides the following critique of underconsumptionist theory: "It is sheer redundancy to say that crises are produced by the lack of paying consumption or paying consumers. The capitalist system recognizes only paying consumers, with the exception of those in receipt of poor law support or the 'rogues.' When commodities are unsalable, it means simply that there are no purchasers, or consumers, for them. When people attempt to give this redundancy an appearance of some deeper meaning by saying that the working class does not receive enough of its own product and that the evil would be dispelled immediately it received a greater share, i.e., if its wages were increased, all one can say is that crises are invariably preceded by periods in which wages in general rise and the working class receives a relatively greater share of the annual product intended for consumption. From the standpoint of these valiant upholders of 'plain common sense,' such periods should prevent the coming of crises. It would appear, therefore, that capitalist production includes conditions which are independent of good will or bad will. . ." [3] Marx argued that the primary source of capitalist crisis was not located in the realm of consumption, but rather, in production. In general, as Anwar Shaikh has argued, production creates the basis for consumption, because it puts purchasing power into the hands of workers and fellow capitalists. To produce anything requires the individual capitalist to buy machines (capital goods) and employ workers.
In Volume III, Part III of Das Kapital, Marx presents a theory of crisis which is solidly grounded in the contradictions he sees in the realm of capitalist production: the Tendency of the rate of profit to fall. He argues that as the capitalists compete with each other, they strive to replace human laborers with machines. This raises what Marx called "the organic composition of capital." However, capitalist profit is based upon living, not "dead" (i.e., machine) labor. Thus as the organic composition of capital rises, the rate of profit tends to fall. Eventually, this will cause a fall in the mass of profit, giving way to decline and crisis.
Many advocates of Marxian economics reject underconsumptionist stagnation theories. However, Marxian economist James Devine has pointed to two possible roles for underconsumption in the business cycle and the origins of the Great Depression of the 1930s. [4]
First, he interprets the dynamics of the U.S. economy in the 1920s as being one of over-investment relative to demand. Stagnant wages (relative to labor productivity) mean that working-class consumer spending also stagnates. As noted above, this does not mean that the economy as a whole must dwell in the economic cellar. In the 1920s, private fixed investment soared, as did "luxury consumption" by the capitalists, boosted by high profits and optimistic expectations. Some growth of working-class consumption occurred, but corresponded to increased indebtedness. (In theory, the government and foreign sectors could have also counteracted stagnation, but this did not happen in that era.) The problem with this kind of economic boom is that it becomes increasingly unstable, somewhat akin to a bubble affecting a financial market. Eventually (in 1929), the over-investment boom ended, leaving unused industrial capacity and debt obligations, discouraging immediate recovery. Note that Devine does not see all booms in these terms. In the late 1960s, the U.S. saw "over-investment relative to supply," in which abundant accumulation pulls up wages and raw material costs, depressing the rate of profit on the supply side.
Second, once a recession has occurred (e.g., 1931–33), private investment can be blocked by debt, unused capacity, pessimistic expectations, and increasing social unrest. In this case, capitalists try to raise their rates of profit by cutting wages and raising labor productivity (by speeding up production). The problem is that while this may be rational for the individual, it is irrational for the capitalist class as a whole. Cutting wages relative to productivity lowers consumer demand relative to potential output. With other sources of aggregate demand blocked, this actually hurts profitability by lowering demand. Devine terms this problem the "under-consumption trap".
Underconsumption theory dates to the earlier economic theory of mercantilism, and an early history of underconsumptionism is given in Mercantilism by Eli Heckscher [5] Underconsumption was a small part of mercantilist theory, in Heckscher's view, but was discussed by a number of authors.
The earliest reference given was to Barthélemy de Laffemas, who in 1598 in The Treasures and riches to put the State in splendor "denounced the objectors to the use of French silks on the ground that all purchasers of French luxury goods created a livelihood for the poor, whereas the miser caused them to die in distress," [6] an early form of the paradox of thrift. A number of other 17th century authors, English, German, and French, stated similar sentiments, which Heckscher summarizes as:
The Fable of The Bees by Bernard Mandeville, of 1714, was credited by Keynes as the most popular exposition of underconsumptionism of its time, but it caused such an uproar, being seen as an attack against Christian virtues, specifically attacking temperance, that underconsumptionism was not mentioned in "respectable circles" for another century, until it was raised in the later Malthus. [8]
Malthus devoted a chapter of Principles (1836) to underconsumption theory, which was rebutted by David Ricardo, in his Notes on Malthus, and which debate continued in private correspondence. [9]
Malthus was credited by Keynes as a predecessor for his views on effective demand [10] and, other than Malthus, Keynes did not credit the existence of other proponents of underconsumption, stating instead that Ricardo "conquered" English economics. [11] This is now understood to be false – other British proponents of underconsumption are now well-established, but, as Keynes demonstrated, they were poorly documented, and by the 1930s not well-known. Further, they did not form a unified school, but rather related heterodox ideas. [12]
The Birmingham School of economists argued an underconsumptionist theory from 1815, [13] and some of the writings of the school's leading member Thomas Attwood contained formulations of the multiplier effect and an income-expenditure model. [14]
In continental Europe, Jean Charles Léonard de Sismondi proposed underconsumption and overproduction as causes of the economic cycle, in his Nouveaux Principes d'économie politique (1819), in one of the earliest systematic treatments of economic cycles. Properly, Sismondi discussed periodic economic crises, while the notion of a cycle was devised by Charles Dunoyer in his reconciliation of Sismondi's work with classical economics.
The multiplier dates to work in the 1890s by the Australian economist Alfred De Lissa, the Danish politician Julius Wulff, and the German-American economist Nicholas Johannsen, [15] [16] Nicholas Johannsen also proposed a theory of effective demand in the 1890s.
The paradox of thrift was stated in 1892 by John M. Robertson in his The Fallacy of Savings, and similar sentiments date to antiquity, [17] [18] in addition to the mercantilist statements cited above:
There is that scattereth, and yet increaseth; and there is that withholdeth more than is meet, but it tendeth to poverty.
The liberal soul shall be made fat: and he that watereth shall be watered also himself.
An underconsumption theory of the economic cycle was given by John A. Hobson in his Industrial System (1910). [19]
William Trufant Foster and Waddill Catchings developed a theory of underconsumption in the 1920s that became highly influential among policy makers. The argument was that governmental intervention, especially spending on public works programs, was essential to restore the balance between production and consumption. The theory strongly influenced Herbert Hoover and Franklin D. Roosevelt to engage in massive public works projects.
Today these ideas, regardless of provenance, are grouped in academia under the rubric of "Keynesian economics", due to Keynes's role in consolidating, elaborating, and popularizing them. Keynes himself specifically discussed underconsumption (which he wrote "under-consumption") in The General Theory of Employment, Interest and Money . [20] [21]
The theory of underconsumption has been criticized by classical economists such as James Mill, Adam Smith who wrote "What is prudence in the conduct of every private family can scarce be folly in that of a great Kingdom," and on grounds of Christian morality. [22] These criticisms were revised by Austrian economics. [23]
Keynesian economics are the various macroeconomic theories and models of how aggregate demand strongly influences economic output and inflation. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy. It is influenced by a host of factors that sometimes behave erratically and impact production, employment, and inflation.
Business cycles are intervals of general expansion followed by recession in economic performance. The changes in economic activity that characterize business cycles have important implications for the welfare of the general population, government institutions, and private sector firms.
Nicholas Kaldor, Baron Kaldor, born Káldor Miklós, was a Hungarian economist. He developed the "compensation" criteria called Kaldor–Hicks efficiency for welfare comparisons (1939), derived the cobweb model, and argued for certain regularities observable in economic growth, which are called Kaldor's growth laws. Kaldor worked alongside Gunnar Myrdal to develop the key concept Circular Cumulative Causation, a multicausal approach where the core variables and their linkages are delineated.
Classical economics, classical political economy, or Smithian economics is a school of thought in political economy that flourished, primarily in Britain, in the late 18th and early-to-mid-19th century. Its main thinkers are held to be Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill. These economists produced a theory of market economies as largely self-regulating systems, governed by natural laws of production and exchange.
Jean Charles Léonard de Sismondi, also known as Jean Charles Leonard Simonde de Sismondi,, whose real surname was Simonde, was a Swiss historian and political economist, who is best known for his works on French and Italian history, and his economic ideas. His Nouveaux principes d'économie politique, ou de la richesse dans ses rapports avec la population (1819) represents the first liberal critique of laissez-faire economics. He was one of the pioneering advocates of unemployment insurance, sickness benefits, a progressive tax, regulation of working hours, and a pension scheme. He was also the first to coin the term proletariat to refer to the working class created under capitalism, and his discussion of mieux value anticipates the concept of surplus value. According to Gareth Stedman Jones, "much of what Sismondi wrote became part of the standard repertoire of socialist criticism of modern industry," earning him critical commentary in the Communist Manifesto.
In classical economics, Say's law, or the law of markets, is the claim that the production of a product creates demand for another product by providing something of value which can be exchanged for that other product. So, production is the source of demand. In his principal work, A Treatise on Political Economy, Jean-Baptiste Say wrote: "A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value." And also, "As each of us can only purchase the productions of others with his/her own productions – as the value we can buy is equal to the value we can produce, the more men can produce, the more they will purchase."
In economics, effective demand (ED) in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market. In the aggregated market for goods in general, demand, notional or effective, is referred to as aggregate demand. The concept of effective supply parallels the concept of effective demand. The concept of effective demand or supply becomes relevant when markets do not continuously maintain equilibrium prices.
In economics, overproduction, oversupply, excess of supply or glut refers to excess of supply over demand of products being offered to the market. This leads to lower prices and/or unsold goods along with the possibility of unemployment.
The paradox of thrift is a paradox of economics. The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving. The paradox is, narrowly speaking, that total saving may fall because of individuals' attempts to increase their saving, and, broadly speaking, that increase in saving may be harmful to an economy. The paradox of thrift is an example of the fallacy of composition, the idea that what is true of the parts must always be true of the whole. The narrow claim transparently contradicts the fallacy, and the broad one does so by implication, because while individual thrift is generally averred to be good for the individual, the paradox of thrift holds that collective thrift may be bad for the economy.
Michał Kalecki was a Polish Marxian economist. Over the course of his life, Kalecki worked at the London School of Economics, University of Cambridge, University of Oxford, and Warsaw School of Economics, and was an economic advisor to the governments of Poland, France, Cuba, Israel, Mexico, and India. He also served as the deputy director of the United Nations Economic Department in New York City.
The history of economic thought is the study of the philosophies of the different thinkers and theories in the subjects that later became political economy and economics, from the ancient world to the present day.
In macroeconomics, a general glut is an excess of supply in relation to demand, specifically, when there is more production in all fields of production in comparison with what resources are available to consume (purchase) said production. This exhibits itself in a general recession or depression, with high and persistent underutilization of resources, notably unemployment and idle factories. The Great Depression is often cited as an archetypal example of a general glut.
Nobuo Okishio was a Japanese Marxian economist and emeritus professor of Kobe University. In 1979, he was elected President of the Japan Association of Economics and Econometrics, which is now called Japanese Economic Association.
The following outline is provided as an overview of and topical guide to economics:
Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
Throughout modern history, a variety of perspectives on capitalism have evolved based on different schools of thought.
An Essay on Marxian Economics is an analytical essay written by in 1942 by economist Joan Robinson. The essay deals with the orthodox teachings of capital accumulation, the essential demand crisis and real wages by comparing it to Karl Marx's Das Kapital. It is a wide-ranging critique on Marx and Orthodox economics while also arguing for a long-term economic view that builds on the problems that Marx first identified in the exploitative nature of capitalism.
Crisis theory, concerning the causes and consequences of the tendency for the rate of profit to fall in a capitalist system, is associated with Marxian critique of political economy, and was further popularised through Marxist economics.
Marxism and Keynesianism is a method of understanding and comparing the works of influential economists John Maynard Keynes and Karl Marx. Both men's works has fostered respective schools of economic thought that have had significant influence in various academic circles as well as in influencing government policy of various states. Keynes' work found popularity in developed liberal economies following the Great Depression and World War II, most notably Franklin D. Roosevelt's New Deal in the United States in which strong industrial production was backed by strong unions and government support. Marx's work led the way to a number of socialist states, notably the Soviet Union and the People's Republic of China. The immense influence of both Marxian and Keynesian schools has led to numerous comparisons of the work of both economists along with synthesis of both schools.
A history of economic thought is a book by the Russian economist Isaak Illich Rubin (1886–1937). A second revised edition published in Russian in 1929 was first translated into English by Donald Filtzer and published in 1979. The book covers the period from mercantilism in the 16th century to the decline of the classical school of political economy with writers like John Stuart Mill in the mid-19th century. It critically appraises the theories of major writers, and places their thought in the context of the economic and social changes of their day. It adopts a Marxist standpoint in making critiques, but Marx's work is not itself discussed at any length. The book ends with the state of economics as Marx found it when he first turned to it in the mid-19th century. Rubin's other major work, Essays on Marx's theory of value, takes up Marx's own contributions.