Underconsumption and the end of excess demand
Yesterday’s post on the failure of Japan’s monetary policy experiment drew some favourable commentary from a prominent macroeconomist that I want to run by you. The gist of his insight is that we have long been living in an age of an excess supply which is only now being made plain. Let me run the tenor of his comments by you and make some additional ones of my own.
Here’s what he wrote:
“we don’t live in a world of scarce savings any longer, we live in a world of weak demand. Desired investment no longer substantially exceeds actual investment.
…In the 17th, 18th and most of the 19th Century, not coincidently the world in which classical economic theory was born, desired investment was substantially higher than actual investment because on one side we had technological innovations that created huge investment needs and on the other we simply were not wealthy enough to save much and our financial systems were inefficient in converting what savings we did have into investable forms. In that world supply-side policies that promoted income inequality or that boosted productivity were indeed generally pro-growth because capitalists could access the higher savings generated to invest productively.
Except for a brief period after WW1 and WW2, however, we’ve lived since then in a world of savings abundance, as wealth creation exploded and financial innovations by the likes of Credit Mobilier and Jay Cooke converted savings into capital. For that reason desired investment in most major economies no longer exceeds actual investment (except in developing countries unable to attract capital) and in at least one major economy, China, actual investment in fact substantially exceeds desired investment.
As you point out, only growth in global consumption — which brings with it growth in desired investment needed to satisfy that consumption — will result in overall growth. To get growth in the short term we must boost public sector investment or in the long term we must boost consumption, with the corresponding increase in private investment, which effectively means directly or transferring wealth to workers at the expense either of the rich (nearly everywhere), of businesses (Germany), or of the state (China). Supply-side policies do the opposite.
By the way, in case you are not very familiar with their work (although I suspect you may be), John Hobson and his American contemporary, Charles Arthur Conant, already explained 95% of this in the late 19th Century. They also explained (and Lenin picked up on Hobson) that imperialism in Asia and Africa was driven primarily by the need to export savings and import demand. As I write this it occurs to me that late imperialism was perhaps a demand-side solution to a problem of excess savings whereas earlier colonization — including the slave trade and the search for cheaper ways to “produce” sugar, spice, cotton, etc. — was a supply-side solution to insufficient wealth available for investment. This might be a little too glib, however, as it immediately occurs to me that destroying Indian textile manufacturing was “demand-side” for the British, and it is hard to see the Belgians in the Congo as anything other than an especially vicious form of supply-side.
He suggests we start using the world “Underconsumption”. The interesting bit here is the notion that the excess demand in the developed economy has been around for nearly 100 years.
So let me piggyback on his argument and see what you think. And by the way, I don’t believe this per se, but I want to make the argument to tease out some of the political economy factors. Here it is:
Let’s assume that the excess demand of the 1950s and the 1960s petered out when the reconstruction of World War 2 damage was largely completed – just as it petered out after the 1920s after World War I. At some point in the 1970s, industrialists – in America in particular, but also in other places – woke up and realized that they couldn’t actually increase profits a lot by selling stuff to domestic consumers or even to other big economy consumers.
They weren’t ready to give up on the supply-side paradigm though. So they had to look abroad into what we now call the emerging markets. The ones who started selling their wares to the so-called LDCs got burned by repeated crisis there in the 1980s and the 1990s. But sometime after the fall of the Berlin Wall, many parts of the emerging markets started to look pretty good.
Fast forward to 2008 and these industrialists are now unbelievably rich. Over a period of some 25 years, they have avoided the perils of underconsumption in the developed economy and gotten rich by using supply side thinking in the emerging markets, especially China.
But of course, now even in China, supply is in excess. And the question of how to increase profits has taken on a new urgency in a world of increased political revolt. The revolt is due mainly to the fact that industrialists have not compensated the workers cum consumers of developed economies for their productivity increases. Instead, they have increasingly turned to emerging markets for both production and revenue in order to continue making profits. And after a big financial crisis, developed economy workers thought their lot would change. It hasn’t.
The Germans tell us that the way out is to export well in excess of importing. But that invariably means someone has to import well in excess of exporting. And what the rise of Donald Trump is telling us is that this paradigm is unstable. The importers won’t continue to take on the excess supply.
For me, the big question is what happens in the next cyclical downturn. That has always been the question. I think policymakers have been quite adept at keeping this recovery going. But that hasn’t made the demand-side problems go away. If no one is able or willing to take up the excess supply when the economy runs aground, expect the politics of populism to become more radical still.