Overproduction or mis-configuration of production?

January 15th, 2008

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Recently, the US employment data was released. With it, came the dismal news that employment growth was much less than expected. As this MarketWatch article, U.S. stocks pressured by jump in unemployment, says,

“Since 1949, the unemployment rate has never risen by this magnitude without the economy being in recession,” said John Ryding, chief U.S. economist, Bear Stearns.

Whenever we think about the unemployment rate, which is expressed as a single number, it can easily give us the picture of the employment facet of the economy as one big monolithic jobs-producing machine. With this highly abstract picture, it looks as if the economy is meant to produce a quantity of abstractly uniform ‘things,’ given a quantity of abstractly uniform ‘labourers.’ That was how it seemed to look like during the Great Depression, which Wilhelm R?pk wrote in this deeply buried 1936 classic (originally written in German), Crises & Cycles,

The paradoxical nature of the crisis is characterized by the fact that production is curtailed in every direction, and there is no work anywhere, while so far as the economic position of millions of people is concerned, we could really be doing nothing better than getting every ounce of product out of men and machinery.

When we think along this line, it is easy to think of economic downturns of just being a mismatch between the quantity of production and consumption. As Wilhelm R?pk continued,

It is an indisputable fact that a general slump, which does not permit of the scale of production reached in the boom being maintained, sets in during the crisis, and it is equally indisputable that this general slump is the result of the total demand suddenly falling behind the total supply. But let us make sure what this means and what it does not mean. Under no circumstances can it mean that the cause of the general slump is to be sought in the fact that production has outstripped consumption and that too many of all goods at once are being produced.

To explain this point further, Wilhelm R?pk came up with a metaphor:

The struggle against the scarcity of goods which we are condemned to wage for all time, and always with inadequate forces, can be compared to the struggle of the German army against the superior numbers of their opponents during the World War. Every soldier was used in that struggle, and the Germans would have been glad if they had had at their disposal more millions of men, or of tanks to replace soldiers, such as their enemies had. Nevertheless it happened, owing to difficulties of organization which could scarcely be avoided in such a huge and complicated structure as the German army, that from time to time isolated troops were kept out of action, while at other places on the front they were sorely needed. Thus a scarcity of soldiers in general was here accompanied by a superfluity of soldiers at certain isolated places. No one in possession of his senses would have concluded from this that these soldiers who were temporarily kept out of action should have been sent home as superfluous or that the ‘work’ of the army could have been ‘spread’ by lengthening the men’s leave or replacing guns by halberds and pikes.

Therefore, when you read mainstream news stories about countries (e.g. China) heading towards economic crisis due to the accumulation of over-investments and over-production, you know it is an inaccurate explanation. As Wilhelm R?pk continued,

An economic crisis (that of to-day like those of the past) can therefore not be interpreted as a general over-production of all goods at once, a surpassing of the possibilities of consumption by the possibilities of production, but only as a lack of proportion between the different lines of production, in short, as a functional disturbance within the highly complicated modern exchange economy. The disparity between the goods at our disposal and our unsatisfied wants is more obvious than ever, but the wheels of the machine which delivers the goods do not fit together properly at times of crisis.

This is the key insight from the Austrian School of economic thought. Over-production or over-investment is not the problem. Rather, the trouble lies in the mis-configuration of production and mal-investments (see The first step in an economic slowdown?mal-investment in capital).

This concept is crucial in understanding the Austrian Business Cycle Theory (see What causes economic booms and busts?)