Underconsumption Is Not the Problem
Enough to buy back the product?
Paul Krugman recently declared that our real economics problem is this: “What’s limiting employment now is lack of demand for the things workers produce.” Not surprisingly, this issue has been thrown about in socialist literature for more than a century.
The idea that an economy operates only if workers are paid “enough to buy back the product” is an important assumption behind Marxism. Keynesians have embraced this fallacy, and the pursuit of solutions based on “buy back the product” is the main reason our economy today is in crisis and will remain so for years to come.
It has been more than two centuries since Thomas Malthus (yes, that Thomas Malthus, the overpopulation prognosticator) conjured up the “underconsumption” theories in his many letters to David Ricardo. Indeed, I believe Malthus would have been quite comfortable not only with Krugman, but also the entire Keynesian paradigm, which is little more than Malthusian economics dressed up in the equation of Y = C + I + G (total income equals consumption plus investment plus government spending).
Unfortunately, it seems that in modern political economy Malthus and Keynes have won. Recently, President Barack Obama declared that his government “will spend our way out of the recession,” which is another way of saying that the government will find clever ways to put money into the hands of people who have produced nothing or very little for it and then encourage them to spend, spend, spend.
Policies based on the “underconsumption/overproduction” fallacies are an unmitigated disaster, and are responsible in large part for U.S. economy’s failure to really recover. Those who champion this irresponsibility are claiming we can have consumption without requisite production; just print money and everything else takes care of itself.
Hazlitt to the Rescue
Henry Hazlitt in his classic, Economics in One Lesson, saw through this nonsense from the beginning. Chapter 21, “Enough to Buy Back the Product,” lays out the many reasons why the “underconsumption/overproduction” explanations of recessions not only are wrong but also lead to destructive policy outcomes.
Hazlitt perceptively noted: “In an exchange economy everybody’s money income is somebody else’s cost.” In the case of the “stimulus,” the administration paid for it through taxation, borrowing, and printing new money. With all three methods the net result was that someone was made better off but only at the expense of someone else. When the government forced up the minimum wage (to improve “purchasing power” by lower-wage workers), there was no added amount of production to offset the increase in business costs. Instead, we have seen a record level of teenage unemployment, something that a student properly trained in the principles of economics could have foreseen.
As Hazlitt explains, whenever government tries to force up wages (while imposing new regulations that reduce business productivity), real purchasing power falls. That is because the negative effects – which are unavoidable when such policies are implemented – will always outweigh the so-called positive effects. In other words, while money wages might increase for some people, overall, government has forced up business costs, so less is produced.
Some people individually benefit from such government actions, and the statist news media tend to concentrate on those recipients in order to give the impression that the policy benefited society overall. However, there is no way to avoid the negative consequences. As Jean-Baptiste Say, the great French economist of the early nineteenth century, pointed out, consumption ultimately is made possible by more production.
The problem in our economy is not that we are “producing too many goods,” or that “people cannot buy back what is produced” because they are not paid enough, or that government has not flooded the economy with enough new money. No, the problem is that much of the structure of production has been geared toward generating projects that cannot be sustained.
The only way that the economy truly can recover is for us to permit these malinvestments either to be liquidated or be directed toward other, sustainable lines of production. Instead, the government tries to throw new money at us and claim that we just are not spending enough.
That’s a prescription for disaster.
Comment by Steve Farrell on 10 March 2010:
Good thoughts as always!
Pingback by Underconsumption Is Not the Problem « thak’s cool links on 10 March 2010:
[...] The Freeman | Ideas On Liberty » Underconsumption Is Not the Problem. More on the Keynesian fallacy. [...]
Comment by Peter Marengo on 10 March 2010:
Excellent analysis – the more people understand this the more they become appalled by statism in all of its forms
Comment by Tim on 13 March 2010:
Basically economic law applies just as stringently to nations as it does to individuals. One cannot produce wealth merely through consumption. Wealth creation depends the efficient use of scarce resources and the only way that can be acccomplished is via the free market. Once government intrudes, political choices supplant market choices and society is made poorer. After all, if politicians were blessed with keener insight into the public’s wants, they’d stop being politicians and become entreprenuers and earn their money through voluntary transactions rather than extortion.
Comment by Terry Thorsen on 14 March 2010:
I agree with the article but draw issue with the conclusion that the raise in minimum wage affected teenage employment. The primary driver of employment is the *need for workers*. In a deleveraging economy the majority of businesses scale back due to capital constraints and falling revenue. For businesses, the cost of the worker affects profit margins but (except in boom times) does not impact the quantity of workers hired.
This translates to logic that doesn’t require a degree in economics. A bad economy means there is less work. Teenage employees are more likely the victims of their own relatively low productive value. If this were not the case then we would instead expect to see low cost teenage workers *retained* at the expense of higher cost workers. We would see cashiers being promoted to middle management.
Certainly at some point a high wage conflicts with the level of employment but I suspect that this effect to be a curve. I doubt very much that a 50 cent change in the minimum wage really has a significant effect on employment rates whereas the effect of mandated health insurance at $7,000 a year would put quite the damper on hiring.
Not to say that higher labor costs are good news. The primary result of artificially high labor prices is a higher cost of goods (per the law of cost of supply). Higher costs put goods out of the reach of a greater number of people and thus lower the standard of living. I can’t help but feel that when we argue against the minimum wage that we are off tack, making the argument a question of employment rates (which plays right into the neo-classical court) as opposed to lowered costs of living which is a demonstrably positive result.
Comment by Sherwood Kaip on 24 August 2010:
Mr. Thorsen, your statement that “The primary driver of employment is the *need for workers*.” is slightly misleading. The primary driver of employment is that the employer get more in value (profit) from his employees than he pays (If he gets less, it’s called bankruptcy). Just like in all economic trades, both the employer and employee expect to gain–if either thinks he is losing, there will be no trade.
If raising the minimum wage has no significant effect on employment, let’s raise the minimum wage to $100 dollars per hour and we’ll all be rich–or out of jobs til we get it all sorted out!
If the object is to raise the average wage, one of the simplest ways to do it is to kill everyone who makes less than the current average wage. Come to think of it, that’s what we do when we raise the minimum wage above what some people are worth to an employer. We cut off the bottom rungs of the economic ladder for the least productive (currently) among us, often people who are just trying to get into the work force. If employers can profit from hiring (more) workers, they will do so. If they can’t, they won’t. Would you be willing to hire and manage 100 workers for no profit, even if you didn’t go bankrupt either?
While it is certainly true that employers will pay no more than they have to, it is also equally true that workers will work for no less than what they can get.
Pingback by Jan to July 2010 Browseworthy Stories Archives « Clear Thinking on 1 February 2011:
[...] 3-10-10 William Anderson at The Freeman Online NYT’s head progressive economist zealot gets it wrong–again. Underconsumption Is Not the Problem [...]