Underconsumption

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, i.e., the level of production corresponding to full employment.

One of the early underconsumption theory 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. This, of course, ignores other sources of demand, to which we return below.

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 is not 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.)

Modern Keynesian economics has largely superceded underconsumption theories.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.

Most economists reject crude underconsumption theories. But that does not mean that underconsumption forces cannot play a role in the dynamics of the economy. For example, many or most advocates of Marxian political economy reject underconsumptionist stagnation theories. Instead, they see capitalism as a socio-economic system that is always driven ahead by the accumulation (investment) of capital (to enrich capitalists and to survive the battle of competition). However, Professor 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 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 underconsumption trap.