The New Palgrave Dictionary of Economics

2018 Edition
| Editors: Macmillan Publishers Ltd

Overproduction

  • B. A. Corry
Reference work entry
DOI: https://doi.org/10.1057/978-1-349-95189-5_1660

Abstract

The term overproduction, or general gluts as it was earlier called, and its allied, if not synonymous term, underconsumption, are rarely, if at all, to be found today in standard, orthodox textbooks of economics. Yet for past generations of writers on economics they were familiar concepts about which must ink was spilt and heated debate ranged. Discussions of overproduction were closely bound up with discussions of underconsumption because the latter has tended to be one of the main explanations of overproduction. Hence our analysis of the concept of overproduction and a brief survey of the development of theories to explain it, has to include some discussion of underconsumption.

The term overproduction, or general gluts as it was earlier called, and its allied, if not synonymous term, underconsumption, are rarely, if at all, to be found today in standard, orthodox textbooks of economics. Yet for past generations of writers on economics they were familiar concepts about which must ink was spilt and heated debate ranged. Discussions of overproduction were closely bound up with discussions of underconsumption because the latter has tended to be one of the main explanations of overproduction. Hence our analysis of the concept of overproduction and a brief survey of the development of theories to explain it, has to include some discussion of underconsumption.

The absence of these terms from orthodox economics has occurred for several reasons; first they are somewhat ambiguous as regards their meaning, and as we shall illustrate in the course of our discussion, it was never clear what particular writers had in mind when they wrote of general gluts, overproduction or underconsumption. A second reason for the decline in use of the terms has been the growth of formal model construction in macroeconomics where emphasis is placed on the econometric estimation of the model rather than on an intuitive vision of the way capitalism does, or does not, operate.

The common presumption underlying all theories of overproduction, and by implication theories of underconsumption, is that capitalist market economies have a built-in flaw, which may or may not be correctable. This flaw is that the level of spending may not be sufficient to sustain the volume of output produced at full employment, so that there will be output not sold, or at least not saleable at prices that make it profitable to produce, hence overproduction will occur and eventually production will contract and general unemployment occur. Underconsumptionists argue that this overproduction arises primarily because consumption is too low and this has been overwhelmingly the main line of approach in the overproduction school.

We have already referred to ambiguities which has surrounded the use of the terms. We must now state these ambiguities and look on them in some detail. Then we shall give a brief account of the histories of the doctrines.

The first ambiguity is whether overproduction is inevitable, i.e., must always occur, or whether is occurs at certain times, e.g., at the peak and downturn phase of the trade cycle. It has been argued by some writers, for example, that the incomes earned in the production of output even if spent in their entirity on output, that is on both consumption and capital goods, could never enable producers to recoup their costs including a normal rate of return on capital. This was the basis of the famous A + B theorem associated with Major Douglas and the Social Credit Movement. The A + B theorem failed to recognize the accounting identity that the sum of income earned in production, must in a closed system, equal the sum of expenditures – so that total output could be bought at prices that would recoup production costs.

Another form of this inevitability argument was the view that the act of saving or rather any attempt to save was a leakage from the circular flow of income and would result in unsold output. The reasoning here was that saving is ‘unspent’ income, hence income earned in the production process is not returned to the income stream so production costs – including a necessary profit element – cannot be recouped. Put another way this view of underconsumption or overproduction assumes that consumption is the only form of expenditure. This view – what we may term crude underconsumption – is quite common in the earlier popular literature. A good example from the early 18th century is Bernard de Mandeville’s famous Fable of the Bees, where ‘Knaves turn honest’, decrease their consumption and increase: thriftiness’ and cause the economy to slump. In the early 19th century similar views are to be found in a group of English writers such as W. Spence who found the basis for their underconsumption views within a Physiocratic framework.

The Classical economists, in the main, refused to consider overproduction as a possibility and their main weapon of defence was Say’s Law (after J.B. Say, although the basic texts of it are to be found in Adam Smith). There are several varieties of Say’s Law ranging from a mere tautology to Keynesian-like versions, but the basic idea is that decisions to save are automatically translated into decisions to spend on capital accumulation, so that the circular flow of income is maintained and overproduction cannot occur. The automatic regulator of this mechanism was assumed to be the rate of interest, equating on the one hand to desire of entrepreneurs to use resources for investment purposes with, on the other hand, the desire of households to save income.

Another ambiguity concerns the problem as to whether those writers who spoke of overproduction had in mind what we may term actual overproduction or potential overproduction. Those who believed in actual overproduction envisaged situations where output would actually be produced that could not be sold at prices that covered necessary costs of production. Now this is clearly a most unlikely situation; decision takers are assumed to act rationally given the information available to them; they presumably can estimate fairly accurately the market opportunities open to them so that they simply will not produce unprofitable output. The sequence of events is rather as follows; if there is an unexpected fall in demand producers may be unsure whether the fall is temporary or permanent hence, in the short run they may continue output at its current level and allow stocks to accumulate. Once the decline in demand is seen as a longer term phenomenon they will cut back production and hence we observe not actual overproduction but potential overproduction in the sense that the capital and labour available for output could produce more than is actually being produced.

The other major theme is the under consumptionist approach to overproduction was the unequal distribution of income, especially the relative shares of wages and profits in national income. The argument here, elements of which can be found in Sismondi and Malthus, for example, was most strongly made by J.A. Hobson. He argued that the low level of average wages leads to a high level of saving and capital accumulation, which could not receive a satisfactory rate of return because of the low consumption that the unequal distribution of incomes entailed.

We have already mentioned that fears of overproduction and/or underconsumption go back into the history of economic discussion but there are three contributions in particular that merit special discussion and of which we now give a brief account. They are (i) the Malthus–Ricardo debate; (ii) Marx’s treatment of overproduction; and (iii) Keynes’s treatment of overproduction.

In the early 19th century, at the end of the Napoleonic wars, there was an important economic controversy which has at its heart the very question of the possibility of overproduction, or, as it was then called ‘general glut’. This was the famous controversy between Malthus and Ricardo; it was the first major debate on the subject of overproduction where, for the first time, Say’s Law was paraded against the overproductionists and came out victorious. This victory really lasted in official, academic circles until Keynes’s General Theory of the mid-1930s.

A brief look at this debate is instructive for any understanding of the disappearance of worries about macro-performance from the mainstream of economics until Keynes, although it remained central to the ‘underworld’ of Marxist and other dissenting branches of the subject.

The economic depression of the United Kingdom that followed the Napoleonic Wars had various contemporary explanations. The standard explanation, very much espoused by David Ricardo, was that with the transition from war to peace the structure of production had to be realigned to the demands of a peacetime economy so that there were ‘sudden changes in the channels of trade’ with some markets in excess demand and some in excess supply, but general excess supply was impossible.

Other writers, amongst whom perhaps Malthus was the most prominent, argued that the depression was due to the failure of effective demand, which had been boosted during the war by government expenditure, and that overproduction had occurred and caused the stagnation of output and employment. In the event Ricardo, using what we earlier termed Say’s Law, won the day, and arguments that positive government macro-policy were needed to ensure stability in the volume of employment disappeared from orthodox reasoning until the victory of Keynesian economics. It is of interest to note that the current version of the New Classical Economics has reverted to the pre-Keynesian way of thinking.

Marx’s attitude towards overproduction and underconsumption as its major explanatory cause is complicated and has caused much debate among Marxist scholars, so that a brief summary of his position is fraught with difficulty. He certainly did not accept the inevitable argument of the former that production could never be sold at profitable prices. The analysis he gives of the conditions for sectoral balance are sufficient to demonstrate that equilibrium was possible. His refutation of Say’s Law really comes from his analysis of capitalist monetary economics and its contrast with a pre-capitalist, barter-type economy. Once commodities no longer exchange for commodities but for money, which may or may not then exchange immediately for further commodities, the possibility arises that a particular volume of output may not be sold at profitable prices hence contractions of output and employment will occur.

It is not clear that Marx’s analysis of possible crises can be classified as underconsumptionist in the sense depressions that are thought to be due to insufficient demand for consumer goods. Marx’s theory of the cycle is basically constructed around a theory of fluctuating investment, as have practically all subsequent theories of the cycle, and the sequence he proposed was that an initial increase in demand for output would lead to an increase in the demand for labour which, in turn, would tend to force up the average real wage. This latter effect would reduce the rate of profit and check capital accumulation, hence output and employment would decline until real wages fell sufficiently to restore profitability. This is hardly an analysis that it is appropriate to level as underconsumptionalist.

Keynes, in his General Theory, set himself as one of his major tasks the overthrow of Say’s Law. He accepted the idea that there was a tendency towards macro-equilibrium under capitalist organization. But, and it is an important but, this equilibrium was where the forces of investment and saving were balanced which was not necessarily at a level of output that would ensure full employment of labour. He further argued that this macro-equilibrium was stable so that any higher level of output produced, unless there were changes in the structural parameters of the system, would result in losses and so output and employment would contract back to its equilibrium level. In this sense Keynes accepted overproduction as a basic feature of capitalism. Was Keynes also an underconsumptionist? Not in the sense that he thought a failure of consumption expenditure was an initiating cause of a downturn in economic activity. He regarded consumption as reacting passively to income, so that a fall in income has to precede the fall in consumption in Keynesian analysis. However, his theory of the multiplier does suggest that a rise in the average or marginal propensity to consume would, for any given level of investment, lead to a higher level of output and employment.

We have seen that the term overproduction is not without its ambiguities and it is perhaps for this, and other reasons that we have given, that it is no longer in common use in orthodox economies. However the very fact that we currently observe capitalist economics producing well below their full-employment potential should make us take seriously those earlier fears of overproduction and the analyses that seek to demonstrate why it occurs. Moreover, any macrotheorizing that is prepared to acknowledge that total output may be demand constrained is accepting (implicitly or explicitly) the possibility of potential overproduction in capitalist economies.

See Also

Bibliography

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Copyright information

© Macmillan Publishers Ltd. 2018

Authors and Affiliations

  • B. A. Corry
    • 1
  1. 1.