Everything about Underconsumption totally explained
In
underconsumption theory, recessions and
stagnation arise due to inadequate consumer demand relative to the amount produced. It is an old concept in
economics, going back to
Thomas Malthus if not earlier. The concept of underconsumption has 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, for example, 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 can't buy back as much as they produce. Thus, there will always be inadequate demand for the product. This, of course, ignores other sources of demand, to which we return below.
Foster and Catchings
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 imbalance between production and consumption. The theory strongly influenced
Herbert Hoover and
Franklin D. Roosevelt to engage in massive public works projects.
Theory
In his book
Underconsumption Theories (International Publishers, 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 isn't seen as part of
business cycles as much as (perhaps) the general economic environment in which they occur. (See
"Underconsumption"
for this theory's role in
business cycle analysis.)
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Keynesian economics has largely superseded underconsumption theories.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's possible in Keynesian economics that falling consumption (say, due to low and falling real wages) can cause a recession or deepening stagnation.
Marxian
Marx himself wrote, in Volume II of Das Kapital, 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 doesn't receive enough of its own product and that the evil would be dispelled immediately it received a greater share,for example, 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. . . " [asquoted by Franz Mehring in his biography of Karl Marx, p. 404 of the 1935 Covici, Friede edition, tr. Edward Fitzgerald]. Marx argued that the primary source of capitalist crisis wasn't 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" (for example, 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.
Like Marx, many or most advocates of
Marxian political economy 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. (See his
"The Origins of the 1929-33 Great Collapse: A Marxian Interpretation".)
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 doesn't 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 didn't 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 doesn't 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 (for example, 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's 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.
Further Information
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