There's No Such Thing as "Overproduction"
JANUARY 01, 2003 by THOMAS E. WOODS JR.
A most stubborn economic fallacy, especially in my own discipline of history, is that in the unhampered market, output can exceed demand. This is the alleged problem of “overproduction.” The result of this calamity, we are told, is that unsold surpluses pile up, leading to mass unemployment, since the natural solution to overproduction is to lay off workers and reduce production.
This fallacy is evident throughout all American history textbooks, especially with regard to two episodes. First, beginning in the late nineteenth century a wide spectrum of intellectuals and politicians began to advance the theory, never questioned by modern textbook authors, that if the United States were to avoid a depression it would need to gain access to additional foreign markets to dispose of its “surplus” finished goods. This thesis was seriously advanced by Captain Alfred Thayer Mahan, known for his book The Influence of Sea Power on History (1890), and appears to have been held in one form or another by many of the major opinion makers of the time.1
The second major episode is the Great Depression. Here again, we are told, America’s productive capacity had outrun its abil-ity to consume (“underconsumption” being a corollary of overproduction), and the result was the Depression. (Never mind that the downturn was actually much worse in capital-goods industries than in consumergoods industries, or that the crash of 1929 became an intractable depression only after systematic and profoundly ill-advised government intervention.2)
Any particular firm could have an interest in promoting the overproduction fallacy (even if it knows it is a fallacy) and its corollary, that the government must find foreign outlets for its excess goods. This is because each firm has a limit to how much of its product it can sell domestically at the price it wishes to charge. Anyone would be grateful if the state would help by “opening” foreign markets to its product so it can sell more at that price.
To the extent that the American economy would have drowned in excess capacity in the 1890s without increased exports, the source of the problem was not the market but interventionism, namely, protective tariffs. As Joseph Stromberg explains: “Tariffs made possible home prices which were well above free-market ones. At the same time, the tariffs created artificial gluts, since the full quantities produced could not be sold at the protected prices. Yet, in order to realize the lower unit costs, the full amounts had to be produced. As Andrew Carnegie put it, ‘The condition of cheap manufacture is running full.” The result, namely “specific, sectoral ‘overproduction’ relative to what could be sold in the home market at tariff enhanced prices,” led such firms to look to foreign markets to dump the excess.3
What, then, is the essential rejoinder to these endless warnings about overproduction? First, it is necessary to point out the obvious — namely, that people’s wants are unlimited. Since we are not living in the Garden of Eden, not all wants are satisfied. So consumers will always want more goods: better cars, more spacious and elegant homes, additional computers, and a host of lesser products that people would doubtless want to have if only they were in greater abundance and hence carried lower prices. There is never any problem, therefore, in cultivating people’s desire to consume. The issue is their ability to consume, and how it can be increased.
It is Say’s Law, developed by the great nineteenth-century French economist J . B . Say, that ultimately explains why there can be no such thing as general overproduction in an unhampered market economy. This law is sometimes summed up as “supply creates its own demand,” but this phrase can be misleading, seeming to suggest that all it takes to foster demand for some good is simply to supply it. In a related error, others have criticized Say for believing that overproduction is impossible in any sector of the economy, a claim he never made. Say was speaking not of individual industries but of the entire economy. In the aggregate, no general overproduction can exist, since production creates the means by which the producers (both capitalists and laborers) can consume. How, after all, apart from receiving alms, can people acquire the products they wish to consume without trading some product that they previously produced (or the proceeds from its sale)?4 In this way, one’s supply constitutes the means by which he can demand the consumer goods he wishes to own.
That the principle behind Say’s Law is clearly true is most easily perceptible in a barter economy. Imagine such an economy in which three consumer goods are produced: apples, oranges, and hats. Now suppose the supply of apples doubles. Are we faced now with overproduction and inevitable depression? Obviously not; the creation of more wealth means greater prosperity. But the greater abundance of apples also means that they will lose some of their purchasing power in terms of oranges and hats. According to the law of diminishing marginal utility, orange and hat sellers will be willing to buy more apples only if they are asked to part with fewer of their own goods in payment. That is to say, the price of apples must fall. Thus the price level adjusts to accommodate the greater supply of apples within the existing purchasing power. Even if apple producers are (temporarily) worse off, there is no general overproduction.5
Overproduction in particular sectors of the economy is rapidly corrected in a free market. To illustrate this, Benjamin Anderson and George Reisman have asked us to suppose the country’s productive power were somehow doubled. We certainly would not want twice as much of everything that we now buy. Most people’s desire for table salt, for instance, is probably already sated. A doubled supply would likely constitute an overproduction of salt — but only to the extent that the other goods which consumers prefer to additional salt are underproduced. The increased capacity to produce salt would best be exploited, therefore, not by doubling the salt output, but perhaps by increasing it only slightly, if at all, and releasing the excess labor and capital to those industries where consumer demand is greater. Economic downturns, then, involve not excess aggregate output but a misallocation of scarce capital from the consumers’ point of view.6
Say himself observed that resources tend to move out of areas where there is a glut and into underexploited areas where increased production holds the prospect of profit. This is sometimes referred to as the uniformity of profit principle. He appears to suggest, however, that political manipulation can interfere with this natural and salutary process: “One kind of production would seldom outstrip every other, and its products be disproportionately cheapened, were production left entirely free.”7
Thus while Say’s Law holds in a free market, political intervention can create the economic problems and radical disorder we sometimes encounter.
Say’s conclusion also suggests why it is wrongheaded during poor economic times to believe that the way out lies in an artificial stimulus to consumption. Say’s Law reminds us of what should be obvious: consumption follows production, both logically and temporally. To consume more, we must increase our real demand for goods in the only way possible — through greater production. What increases our real ability to buy is not a mere increase in green paper tickets that the government can bring about through inflation, but rather an increase in what we ourselves produce so that we can acquire the goods we want.
Adam Smith made the crucial distinction between consumptive expenditure and productive expenditure. Consumptive expenditure uses up some good without providing for its replacement, such as when a person wears out an air conditioner in his home after a series of hot summers. Productive expenditure involves the expenditure of resources for the purpose of creating still more (and/or more valuable) resources in the future, such that the products more than compensate for the goods consumed in their creation. Investment in machinery that increases productivity in some sector of the economy can be an example of productive expenditure. The free market adjusts productive capacity throughout the production structure in accordance with consumer desires — a greater desire to consume leads to a less extensive capital structure and more consumers’ goods in the present, while less consumption in the present results in a more extensive capital structure and fewer consumers’ goods in the present.
James Mill noted the fallacy of economists’ obsession with consumption:
A thousand ploughmen consume fully as much corn and cloth in the course of a year as a regiment of soldiers. But the difference between the kinds of consumption is immense. The labor of the ploughman has, during the year, served to call into existence a quantity of property, which not only repays the corn and cloth which he has consumed, but repays it with a profit. The soldier on the other hand produces nothing. What he has consumed is gone, and its place is left absolutely vacant. The country is the poorer for his consumption, to the full amount of what he has consumed. It is not the poorer, but the richer for what the ploughman has consumed, because, during the time he was consuming it, he has reproduced what does more than replace it.8
In effect, then, exhortations to consume more, or to engage in fiscal policies designed to encourage consumption, essentially prescribe the destruction of wealth as a remedy for economic sluggishness. Rather, we should direct our efforts toward freeing production, the essential source of consumption.
In practice, of course, we do encounter economic difficulties and adjustment problems, but these problems exist because state intervention has impeded the normal adjustment process that rectifies capital misallocation. Sean Corrigan explains why displaced workers often find themselves having difficulty finding employment elsewhere in the economy:
They are unable to find an outlet for their particular skills and talents because the matrix of relative (never absolute, much less average) prices has been made replete with harmful rigidities — thanks to the Fed and the rest of the government — and so cannot adjust to offer them a niche.
Moreover, such niches as do exist are harder to exploit to their maximum because so much scarce capital has been wasted or misallocated, giving people fewer tools with which to work.9
According to the Austrian theory of the business cycle, moreover, the artificially lower interest rates that result from centralbank credit expansion lead to misallocations of capital to projects that will yield consumer goods further into the future than real conditions warrant. That is, the rates mislead investors into believing that consumers are more willing to defer purchases than they actually are (since lower interest rates also come about when the savings pool increases). This kind of credit creation in the 1920s is what made the 1929 bust possible and indeed inevitable.
Such government intervention leads to the allocation of investment funds to areas of production that in the absence of central bank credit would be seen as unprofitable. As a result, recessions and depressions do occur, but they do not disprove Say’s insight. To the contrary, they demonstrate the foolishness of state intervention, which impedes what would otherwise be a natural adjustment of production processes toward a condition in which capital is allocated according to consumer desires.
The alleged problem of overproduction, therefore, about which a great deal more could be said, is no problem at all.1 0 The reason we are so much wealthier now than we were 300 years ago is not that we consume more today. We consume more today because we can produce much more, and it is this production that itself both fuels our ability to consume and increases our standard of living.
1. See Walter LaFeber, The New Empire: An Interpretation of American Expansion, 1860-1898 (Ithaca, N.Y.: Cornell University
2. Murray N. Rothbard, America’s Great Depression, 4th ed. (New York: Richardson & Snyder, 1983).
3. Joseph R. Stromberg, “The Role of State Monopoly Capitalism in the American Empire,” Journal of Libertarian Studies, Summer 2001, p. 71.
4. Receiving alms is not a violation of Say’s Law since the provider of the alms must have produced some good and/or earned the proceeds from the sale of some good.
5. For a detailed discussion of this issue, see George Reisman, Capitalism (Ottawa, 111.: Jameson Books, 1996), pp. 559ff. Reisman also shows how even the apple growers themselves stand to benefit in the long run.
6. Benjamin M. Anderson, Economics and the Public Welfare: A Financial History of the United States, 1914-1946 (Indianapolis, Ind.: Liberty Press, 1979 ), p. 385; Reisman, p. 567.
7. Quoted in William L. Anderson, “Say’s Law: Were (Are) the Critics Right?” Paper presented at the Seventh Austrian Scholars Conference, Auburn, Alabama, p. 11.
8. James Mill, Commerce Defended, chapter 4 “Consumption,” www.capitalism.net/Jamesmil.pdf, p. 7.
9. Sean Corrigan, “Say’s Law for Our Time,” Mises.org, September 5, 2002.
10. For more advanced reading on Say’s Law, see Ivan C. Johnson, “A Reappraisal of the Say’s Law Controversy,” Quarterly Journal of Austrian Economics, Winter 2001, pp. 25-53.