All Commentary
Wednesday, March 10, 2010

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.

  • Dr. William Anderson is Professor of Economics at Frostburg State University. He holds a Ph.D in Economics from Auburn University. He is a member of the FEE Faculty Network.