Underconsumption theory (20TH CENTURY)

Analysis of how total output fails to be sold at the cost of production plus normal profit. Such insufficient consumption within a depressed economy aggravates the economic decline of the state.

A further theory suggests that when there is inadequate buying power in an economy, the government should give periodic injections of money to consumers.

Also see: secular stagnation theory

Source:
G Harberler, Prosperity and Depression (Geneva, 1937)

Theory

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.

Keynesian

Modern Keynesian economics has largely superseded underconsumption theories.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.

Marxian

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”.