Underconsumption
Encyclopedia
In underconsumption theory in economics
, recessions and stagnation
arise due to inadequate consumer demand relative to the amount produced. The theory has been replaced since the 1930s by Keynesian economics
and the theory of aggregate demand
, both of which were influenced by underconsumption.
Underconsumption theory narrowly refers to heterodox economists
in Britain in the 19th century, particularly 1815 onwards, who advanced the theory of underconsumption and rejected classical economics
in the form of Ricardian economics
. These 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
, going 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. 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. This, of course, ignores other sources of demand, to which we return below.
, and an early history of underconsumptionism is given in Mercantilism, by Eli Heckscher
, vol. ii, which is cited and discussed by John Maynard Keynes
in The General Theory, Chapter 23. Notes on Mercantilism, The Usury Laws, Stamped Money and Theories of Under-Consumption, section VII Underconsumption was a small part of mercantilist theory, in Heckscher's view, but was discussed by a number of authors.
The earliest reference given is to Barthélemy de Laffemas, who in 1598 in Les Trésors et richesses pour mettre l'Estat en Splendeur (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," 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 The Fable of The Bees
: or, Private Vices, Publick Benefits by Bernard Mandeville, of 1714, is 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.
, in his Notes on Malthus, and which debate continued in private correspondence.
Malthus is credited by Keynes as a predecessor for his views on effective demand
and, other than Malthus, Keynes did not credit the existence of other proponents of underconsumption, stating instead that Ricardo "conquered" English economics. This is now understood to be false – other British proponents of underconsumption are now well-established, but, as Keynes demonstrates, they were poorly documented, and by the 1930s not well-known. Further, they did not form a unified school, but rather related heterodox ideas.
The Birmingham School
of economists argued an underconsumptionist theory from 1815, and some of the writings of the school's leading member Thomas Attwood
contain formulations of the multiplier
effect and an income-expenditure model.
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 economist Julius Wulff, and the German-American economist Nicholas Johannsen
, Johannsen being cited in a footnote of Keynes. 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, in addition to the mercantilist statements cited above:
in his Industrial System (1910).
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.
and Chapter 23, Section VII.
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 Marxian 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.
(See "Underconsumption" for this theory's role in business cycle
analysis.)
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.
"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. . . " [as quoted 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 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.
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.
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.
and by Austrian economics.
Underconsumption was criticized by 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, as discussed in Keynes, The General Theory, Chapter 23.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, recessions and stagnation
Economic stagnation
Economic stagnation or economic immobilism, often called simply stagnation or immobilism, is a prolonged period of slow economic growth , usually accompanied by high unemployment. Under some definitions, "slow" means significantly slower than potential growth as estimated by experts in macroeconomics...
arise due to inadequate consumer demand relative to the amount produced. The theory has been replaced since the 1930s by Keynesian economics
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
and the theory of aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
, both of which were influenced by underconsumption.
Underconsumption theory narrowly refers to heterodox economists
Heterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...
in Britain in the 19th century, particularly 1815 onwards, who advanced the theory of underconsumption and rejected classical economics
Classical economics
Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill....
in the form of Ricardian economics
Ricardian economics
David Ricardo was born in 1772 and made a fortune as a stockbroker and loan broker. At the age of 27, he read An Inquiry into the Nature and Causes of Wealth of Nations by Adam Smith and was energized by the theories of economics. His main economic ideas are contained in Principles of Political...
. These economists did not form a unified school, and their theories were rejected by mainstream economics
Mainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...
of the time.
Underconsumption is an old concept in economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, going back to the 1598 French mercantilist
Mercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
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. The concept of underconsumption had been used repeatedly as part of the criticism of Say's Law
Say's law
Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...
until underconsumption theory was largely replaced by Keynesian economics
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
which points to a more complete explanation of the failure of aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
to attain potential output
Potential output
In economics, potential output refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The existence of a limit is due to natural and institutional constraints...
, i.e., the level of production corresponding to full employment
Full employment
In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
.
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. This, of course, ignores other sources of demand, to which we return below.
16th century through 18th century – mercantilism
Underconsumption theory dates to the earlier economic theory of mercantilismMercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
, and an early history of underconsumptionism is given in Mercantilism, by Eli Heckscher
Eli Heckscher
Eli Filip Heckscher was a Swedish political economist and economic historian.-Biography:...
, vol. ii, which is cited and discussed by John Maynard Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
in The General Theory, Chapter 23. Notes on Mercantilism, The Usury Laws, Stamped Money and Theories of Under-Consumption, section VII Underconsumption was a small part of mercantilist theory, in Heckscher's view, but was discussed by a number of authors.
The earliest reference given is to Barthélemy de Laffemas, who in 1598 in Les Trésors et richesses pour mettre l'Estat en Splendeur (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," an early form of the paradox of thrift
Paradox of thrift
The paradox of thrift is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees, and similar sentiments date to antiquity...
. A number of other 17th century authors, English, German, and French, stated similar sentiments, which Heckscher summarizes as:
- "the deep-rooted belief in the utility of luxury and the evil of thrift. Thrift, in fact, was regarded as the cause of unemployment, and for two reasons: in the first place, because real income was believed to diminish by the amount of money which did not enter into exchange, and secondly, because saving was believed to withdraw money from circulation."
The The Fable of The Bees
The Fable of the Bees
The Fable of The Bees: or, Private Vices, Public Benefits is a book by Bernard Mandeville, consisting of the poem The Grumbling Hive: or, Knaves turn’d Honest and prose discussion of it. The poem was published in 1705 and the book first appeared in 1714...
: or, Private Vices, Publick Benefits by Bernard Mandeville, of 1714, is 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
Temperance (virtue)
Temperance has been studied by religious thinkers, philosophers, and more recently, psychologists, particularly in the positive psychology movement. It is considered a virtue, a core value that can be seen consistently across time and cultures...
, that underconsumptionism was not mentioned in "respectable circles" for another century, until it was raised in the later Malthus.
19th century
Malthus devotes a chapter of Principles (1836) to underconsumption theory, which was rebutted by David RicardoDavid Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
, in his Notes on Malthus, and which debate continued in private correspondence.
Malthus is credited by Keynes as a predecessor for his views on effective demand
Effective demand
In economics, effective demand 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...
and, other than Malthus, Keynes did not credit the existence of other proponents of underconsumption, stating instead that Ricardo "conquered" English economics. This is now understood to be false – other British proponents of underconsumption are now well-established, but, as Keynes demonstrates, they were poorly documented, and by the 1930s not well-known. Further, they did not form a unified school, but rather related heterodox ideas.
The Birmingham School
Birmingham School (economics)
The Birmingham School was a school of economic thought that emerged in Birmingham, England during the Post-Napoleonic depression that affected England following the end of the Napoleonic wars in 1815....
of economists argued an underconsumptionist theory from 1815, and some of the writings of the school's leading member Thomas Attwood
Thomas Attwood
Thomas Attwood was a British economist, the leading figure of the underconsumptionist Birmingham School of economists, and, as the founder of the Birmingham Political Union, a leading figure in the public campaign for the Great Reform Act of 1832.He was born in Halesowen, and attended Halesowen...
contain formulations of the multiplier
Multiplier (economics)
In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it. More generally, the exogenous spending multiplier is the ratio of a change in national income to any autonomous change in spending In economics, the fiscal...
effect and an income-expenditure model.
In continental Europe, Jean Charles Léonard de Sismondi
Jean Charles Léonard de Sismondi
Jean Charles Léonard de Sismondi , whose real name was Simonde, was a writer born at Geneva. He is best known for his works on French and Italian history, and his economic ideas.-Early life:...
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
Charles Dunoyer
Barthélemy-Charles-Pierre-Joseph Dunoyer de Segonzac was a French liberal economist....
in his reconciliation of Sismondi's work with classical economics.
The multiplier
Multiplier (economics)
In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it. More generally, the exogenous spending multiplier is the ratio of a change in national income to any autonomous change in spending In economics, the fiscal...
dates to work in the 1890s by the Australian economist Alfred De Lissa, the Danish economist Julius Wulff, and the German-American economist Nicholas Johannsen
Nicholas Johannsen
Nicholas August Ludwig Jacob Johansen was a German-American amateur economist, today best known for his influence on and citation by John Maynard Keynes. He wrote under two pen names: A. Merwin and J.J.O...
, Johannsen being cited in a footnote of Keynes. Nicholas Johannsen also proposed a theory of effective demand
Effective demand
In economics, effective demand 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 1890s.
The paradox of thrift
Paradox of thrift
The paradox of thrift is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees, and similar sentiments date to antiquity...
was stated in 1892 by John M. Robertson
J. M. Robertson
John Mackinnon Robertson was a prolific journalist, advocate of rationalism and secularism, and Liberal Member of Parliament in the United Kingdom for Tyneside from 1906 to 1918.- Biography :...
in his The Fallacy of Savings, and similar sentiments date to antiquity, in addition to the mercantilist statements cited above:
20th century – pre-Keynes
An underconsumption theory of the economic cycle was given by John A. HobsonJohn A. Hobson
John Atkinson Hobson , commonly known as John A. Hobson or J. A. Hobson, was an English economist and critic of imperialism, widely popular as a lecturer and writer.-Life:...
in his Industrial System (1910).
William Trufant Foster
William Trufant Foster
William Trufant Foster , was an American educator and economist, whose theories were especially influential in the 1920s. He was the first president of Reed College.- Career :...
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
Herbert Hoover
Herbert Clark Hoover was the 31st President of the United States . Hoover was originally a professional mining engineer and author. As the United States Secretary of Commerce in the 1920s under Presidents Warren Harding and Calvin Coolidge, he promoted partnerships between government and business...
and Franklin D. Roosevelt
Franklin D. Roosevelt
Franklin Delano Roosevelt , also known by his initials, FDR, was the 32nd President of the United States and a central figure in world events during the mid-20th century, leading the United States during a time of worldwide economic crisis and world war...
to engage in massive public works projects.
Legacy
Today these ideas, regardless of provenance, are referred to 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 The General Theory of Employment, Interest and Money, in Chapter 22, Section IV,and Chapter 23, Section VII.
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 depressionDepression (economics)
In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe downturn than a recession, which is seen by some economists as part of the modern business cycle....
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 Marxian tendency of the rate of profit to fall
Tendency of the rate of profit to fall
The tendency of the rate of profit to fall is a hypothesis in economics and political economy, most famously expounded by Karl Marx in chapter 13 of Das Kapital Vol. 3. It was generally accepted in the 19th century...
, which has a similar belief in stagnation as the natural (stable) state, but which is otherwise distinct and in critical opposition to underconsumption theory.
(See "Underconsumption" for this theory's role in business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
analysis.)
Keynesian
Modern Keynesian economicsKeynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
has largely superseded underconsumption theories. Falling consumer demand need not cause a recession, since other parts of aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
may rise to counteract this effect. These other elements are private fixed investment
Fixed investment
Fixed investment in economics refers to investment in fixed capital, i.e., tangible capital goods , or to the replacement of depreciated capital goods which have been scrapped....
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
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 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. . . " [as quoted 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 was not located in the realm of consumption, but rather, in production. In general, as Anwar Shaikh
Anwar Shaikh (economist)
Anwar M. Shaikh is an American economist, and currently Professor of Economics at the Graduate Faculty of The New School in New York City. His work in political economy has focused on the economic theory and empirical patterns of developed capitalism. He has written on international trade,...
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
Tendency of the rate of profit to fall
The tendency of the rate of profit to fall is a hypothesis in economics and political economy, most famously expounded by Karl Marx in chapter 13 of Das Kapital Vol. 3. It was generally accepted in the 19th century...
. 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
Organic composition of capital
The organic composition of capital is a concept created by Karl Marx in his critique of political economy and used in Marxian economics as a theoretical alternative to neo-classical concepts of factors of production, production functions, capital productivity and capital-output ratios. Marx first...
." 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.
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.
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
Economic bubble
An economic bubble is "trade in high volumes at prices that are considerably at variance with intrinsic values"...
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
Potential output
In economics, potential output refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The existence of a limit is due to natural and institutional constraints...
. With other sources of aggregate demand blocked, this actually hurts profitability by lowering demand. Devine terms this problem the under-consumption trap.
Classical and Austrian criticism
The theory of underconsumption has been derided as a fallacy by such classical economists as James MillsJames Mills
James Thomas Mills was a politician in Manitoba, Canada. He served as a Progressive Conservative member of the Legislative Assembly of Manitoba from 1963 to 1966....
and by Austrian economics.
Underconsumption was criticized by Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
, 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, as discussed in Keynes, The General Theory, Chapter 23.