Topic: Economics
The Tall Tale of Economic Overproduction Many of the assumptions of status quo economics, such as the idea of aggregate overproduction, resemble fairy tales more than actual observation.by Gene DeNardo
(libertarian)
Tuesday, October 27, 2009
We are bombarded from mainstream economists with the idea that "overproduction" is at the root of our economic problems. The economy overheats and overproduces and causes a slowdown. How can we not believe this theory, just look at our recent mess. Did not the economy "overproduce" housing? To paraphrase the idea of Bastiat and Hazlitt, what is not seen is often more important than what is seen.
If we examine the results of "overproduction" in relation to individual firms, we have difficulty arriving at the same conclusion. The individual firm has only so many options when faced with the production of more products than the market will consume.
The most obvious is to lower the price until the product sells. Depending on the costs of production, the price can be lowered at or even below costs to clear inventory. There is no concern until the selling price falls below cost. Any amount above cost will keep the company afloat.
When the market indicates that the product must sell below its cost, the company cannot continue production at the same level. It must somehow either cut its costs per unit or produce fewer products, hoping for the same demand and some equilibrium in price.
In an open and free market, the firm is not likely to be operating in a vacuum. In fact, the consumer is probably already finding the same or similar product furnished by a competitor at the lower price, causing the overproduction by the higher priced manufacturer. The firm can only survive with the same product, if it can simultaneously slow production and cut its costs or possibly improve the product, increasing its value to the consumer. It must adapt or wither.
If we accept these conditions, how then can the entire economy, or at least an entire segment of the economy such as housing, overproduce? Wouldn't the individual building firms notice a slackening of sales and adjust their prices or production to compete? Granted housing is an example in which production and sales occur over months rather than hours or days, but the conditions still hold. Even the most dimwitted builder is aware of his inventory at any moment. It is impossible to hide a house that isn't selling at a particular price on a particular day.
Add to that the relative ease at which builders can "adjust" their new product to the economic situation by altering size or amenities to lower price. There is no reason all builders would wait until it was too late and fall into the abyss, like we have been led to believe. And if it holds true for housing, firms with products that have quick turnover should have no problem at all adjusting their production to meet market conditions.
GM is also a good example. Too much auto and truck production and not enough sales, we are told. GM went begging to the government after a year of selling ten million units! That's right, they sold ten million vehicles, yet they were insolvent. What kind of economic factors dictate that selling ten million cars and trucks isn't sufficient? Or, are these economic factors at all?
Overproduction in our present economy is a given. All sectors of our economy are constantly in a state of overproduction. Yet, overproduction, at least significant long term overproduction by the bulk of the economy is impossible in a free market.
In a free economy, with few minor exceptions, production is inseparably linked to consumption. The value created by the product enables exchange and consumption. There can be no aggregate overproduction in a free system.
This does not mean certain goods, as we mentioned, cannot be overproduced. Supply and demand will monitor and keep this tendency in check, encouraging some and possibly completely eliminating other producers. What it does mean is that overproduction by the entire economy is impossible unless you sever the link between production and consumption.
This surely can be influenced by intervention and alteration of the "medium of exchange". Yet, the fundamental underlying conditions remain. It is not until you distort the actual "value" between production and consumption, can overproduction be widespread throughout the economy. That is to say, it is not necessarily money creation that severs this link, but its unequal distribution.
It is price that is the "value" link between production and consumption. No matter the overproduction, price, if low enough, will eventually clear inventory. Why is this?
It is based on the association between price, wage and cost of production. Any price decrease is a wage increase as any price increase is a wage decrease. But, price decreases on products already at market or in inventory do not increase the "cost" of those products. This fact tells us that the cost of labor to produce the "overpriced" and therefore "overproduced" product, when applied to the economy as a whole, has not been a factor.
If these labor costs are "sticky" or are state mandated, then the only future prospect for the employer to lower labor costs is to employ fewer workers. This is not as efficient as a wage decrease since the employer that is let go, can no longer produce, but it is effective in limiting future labor costs.
Still, the cost of expended labor on a product that is already produced and on the market is not a factor in immediate price adjustments during overproduction, simply because the worker has already been paid for the product. The firm has no future liability to the worker for the already completed product. This is part of the devil's pact {labor is paid for the value of labor rather than the product and any difference is the property of the employer} between capital and labor but also part of a marginal outlook on value. Certainly, if you don't buy the labor theory of value, you can't blame inflexibility of price on labor.
That would leave us with the original material costs and capital costs. Material costs in a free market should react to supply and demand in the same way the product would. They are nothing more than a product at a more basic level of the manufacturing process.
If we take housing for an example, wood prices vary daily and are intricately weaved into the demand by builders for wood. Lumber is certainly not a free market item, which the state and state sponsored corporate ownership of our forests are a witness to, but the board foot prices do respond in a fairly swift manner to swings in the industry; as do wholesale copper and other commodity prices. At least fast enough to prevent overproduction throughout the entire sector.
Capitalization is another matter. The "type" of capitalization is extremely important and there are only two types: secured and nonsecured. Secured capitalization has little bearing on price adjustment. Secured capitalization simply determines ownership. If a firm has a lot of secured capitalization and they must lower their prices constantly and eventually can't meet their secured capital responsibilities, they will continue to exist; but they or at least their equipment and buildings will have some new owners. So, declining prices can have an effect on ownership, but secured capitalization in itself does not prohibit price declines.
On the other hand, unsecured capitalization that is secured by the force of the state can lead to liquidation. If the unsecured capital debt will not adjust to falling pricing, then the firm is forced into insolvency and may discontinue production entirely. This refusal of capital to take a vested interest in the firm {or individual} it invests in and use the force of the state to fortify and guarantee the interest is a fundamental building block of economic downturns. By removing capital from the risk of investment, which is a natural consequence of participating in the marketplace, the liability is simply transferred elsewhere.
Bailouts take this process of force one step further by allowing the wilting corporation to continue operation and all unsecured creditors to receive repayment from a third party outside of the contract terms, the consumer tax payer. This is in effect both a wage decrease, as the tax payer loses part of his wages to a contract he has no part in and a price increase, as a contract is fulfilled that has failed, bolstering "false" pricing.
But in a way we digress and in a way we don't. If the product is ultimately the means of exchange, then the entire wage should determine consumption. The aggregate producers in a free economy should always be able to purchase the aggregate product. There is no economic reason to produce that which is not needed and the market should eliminate any tendency to do this. If this is true, overproduction again is impossible in a free system.
This brings us full circle to price. To purchase their product, the producers do not necessarily need wage increases, but they do need freedom of pricing {and of course, freedom from coercion into contracts they are not party to}. We see how forced returns on capitalization can prevent this. The manufacturer is prevented from proper pricing, leaving unsold inventory on the market and withholding wage increases {that would enable purchase}through insufficient price adjustments. Through this process, capital is able to claim a larger share of the value of the product than would be rewarded to it in a free system.
The obvious missing element is competition. It would seem that competition could produce the product in question with a much lower investment of capital, navigating around the barriers to lower price, especially in a down period. Doesn't it seem that some firm, maybe not GM but one or several more efficient companies could produce ten million autos and be in the gravy?
One way this can be prevented is by instituting "barriers of entry", not the least of which is withholding and concentration of capital. And we certainly must tie that into where the value for the product ends up. All payment for labor and entrepreneurship is also potential capital. If this is not allowed to be determined freely, then capital will be directed elsewhere. Misdirected capital is no different than misdirected labor; it almost always ends up a big waste of time and effort.
If overproduction was indeed a problem, we could hand workers shovels instead of tractors, pencil and paper instead of computers or handsaws instead of table saws. We could cut the work week to four days and take long naps at lunch. The object of work is to produce, not to limit production below a certain level so the mysterious economy can remain "balanced". The problem lies when value is coerced to go where it doesn't naturally want to go.
A controlled economy can never find balance. By forcibly taking from one element and giving to the other, there may be temporary benefit to the other, but you can't "adjust" the natural balance sheet like a big buck accountant can "adjust" the corporation's bottom line. Eventually, all debts are called in, whether those keeping score see it that way or not. It's only a matter of time.
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