Wednesday, December 16, 2009

The problem of demand

It is a fundamental assumption of economics that economics is about using markets to allocate scarce resources. This fundamental assumption is very deficient. There is only one primary resource of economic interest — human labor — and that resource has since the beginning of the 19th century been in surplus, not scarcity. Every physical resource, from gold to guns to oil, can be increased mostly without limit by allocating more labor to its production or extraction.

Take oil, for example. Oil is just a means to an end, actually a means to a means to a few ends: Oil is energy, and we use energy to a) power industrial production and b) provide personal transportation. There is, according to Scientific American, about an order of magnitude more energy available in wind and solar power than we would expect to use given pre-depression rates of economic growth for the next fifty years. It will, however, require vast amounts of human labor to build the equipment and infrastructure necessary to capture and distribute this energy. But so what? Right now about one person in six in the most highly industrialized and productive country in the world is un- or under-employed. If there's one thing we have plenty of, it's human labor.

Each and every capitalist economic crisis since the middle of the 19th century has been a failure not of supply but of demand. There has never been a capitalist crisis caused by not producing enough stuff; all capitalists crises are at root caused by not demanding the stuff that we have or can produce.

But what precisely is "demand"?

Demand has two components: what people want and need, and what they "deserve" to have. No matter how much a minimum-wage worker, for example, wants a Ferrari, he cannot demand one. Want and need is more-or-less directly real, actual measurable properties of real human beings. The second, however, is entirely socially constructed; what people "deserve" to have is neither a property of the objective (non-minded) physical world, nor a property of individual human beings. What people "deserve" can be found only in the agreements and social constructions between multiple human beings.

Thus, there are two ways we can have a failure of demand. First, we might be producing things that people simply do not want, or do not want sufficiently to directly or indirectly allocate the labor required for their production. If it takes one hour to produce a shoe, and we are producing so many shoes that people do not want to spend an hour of their labor producing (or earning the money to buy), then we can say that the demand for that many shoes has failed, and we should therefore reduce the supply.

Capitalism, however, handles this sort of "real" demand failure relatively gracefully. The problem comes when the socially constructed form of demand, what people "deserve" to have.

The market for labor is the market for labor power, the ability to produce labor. The cost of labor power is the labor required to provide the worker with the necessities for his or her productivity. The marginal value is the additional productivity generated by the increase in cost. That increasing the cost of labor power produces a greater increase in amount, intensity or quality of labor worked constitutes the natural or ineluctable demand of labor.

But what about the surplus value of labor? The profitability of employing labor is precisely in the difference between the cost of labor power and the amount of labor produced. Under laissez faire capitalism, the worker has no socially constructed demand on his own surplus labor. The only socially constructed demand for this labor, the only people who "deserve" this labor, are the owners of capital, who extract this labor as economic rent.

In the 18th and early 19th century, capitalism got a "jump start" because there was tremendous scope for making workers more productive, which (to some extent) improved the subjective quality of life for many workers. The natural demand of workers in addition to the increased demand of the capitalist class created a direct economic incentive to dramatically increase economic production.

The fundamental purpose of New-Deal consumer capitalism and Keynes' General Theory was to "artificially" increase the demand of workers above and beyond that necessary to create their productivity, to socially construct the idea that workers deserved to themselves consume at least some of their surplus labor. For a lot of interesting reasons (which I'll talk about soon), there has been strong dialectical material and social-evolutionary forces which have eroded this social construction.

The present economic depression is no different: the fundamental problem is failure of demand, mostly the demand of the working class and professional-managerial middle class. The steps are simple. First, in the 1990s and early 2000s, demand was socially constructed to derive from rising asset prices (mostly homes) rather than wage income. Furthermore, these rising asset prices were not caused by either increased cost or increased use-value, but were themselves socially constructed. However, these socially constructed rising asset prices were not at all subject to social control or management, not even the minimal social control provided by the capitalist class. It eventually became impossible to ignore that these rising asset prices were neither based in reality nor intentionally and socially managed, and they collapsed.

Second, internal competition within the capitalist class took the form of financial manipulation — mostly Credit Default Swaps and Collateralized Debt Obligations — which created money out of at best nothing and at worst outright lies and fraud. It again eventually became impossible to ignore the lack of actual foundation in reality or intentional social construction for these financial manipulations.

What happened when asset prices and financial bullshit collapsed? People's wants and needs didn't change. The labor available to supply these wants and needs didn't go away. The capital equipment to amplify people's labor is still there. What changed was the socially constructed sense of what people deserve to have, to convert their wants and needs into demand. People don't "deserve" stuff and cannot therefore demand it. Capitalists therefore produce less stuff, and use less labor, causing unemployment and falling wages. Unemployment and falling wages further decrease socially constructed demand: a person with no job does not "deserve" even to live, much less consume any luxury good. Demand and supply are thus locked into a positive feedback loop of decreasing production and consumption, more colloquially known as a "death spiral".

It's critically importance to understand that the reduced consumption and production is absolutely not caused by there being less stuff to consume or by increased true cost of production. It's caused, paradoxically, by there being too much stuff to consume: so much stuff that the capitalist class cannot earn increasing profit on increasing its production.

Of course, this death spiral is extremely bad for the working class and for all but the most elevated (or specialized) levels of the professional-managerial middle class. But it's also bad for many in the capitalist class, perhaps even a majority of them: you cannot appropriate and exploit the surplus value of an unemployed worker. A large number of people at the "bottom" of the capitalist class are being pushed to the upper professional-managerial middle class, and many of them will descend further into the lower middle class or the unemployed class.

The present financial crisis (as well as the Great Depression) is a classic case of the Prisoner's Dilemma writ large. Although it is in the mutual interest of those in the capitalist, middle and working classes to mutually cooperate to maintain consumer capitalism, capitalism has grossly deficient social mechanisms for suppressing individual self-interest in asymmetric betrayal, eventually causing people to choose the "rational" Nash equilibrium of mutual betrayal and the collapse of consumer capitalism.


  1. I see where you're going with this but, in terms of the economic nomenclature, there's some gray areas that I'd like you to address.

    Even Adam Smith asserted that the fundamental component of any economy is labor. The problem, both as he identified it and as it continues to exist today, is that there is and really can be no fixed metric for labor. Time isn't very useful as an hour spent digging a ditch, an hour spent designing a bridge and an hour spent composing a sonnet can't be reasonably compared. Most metrics of productivity must be framed in terms of what an individual could accomplish in terms of volume and even then there are serious problems in comparison.

    Also, nowhere else does the difference between "demand" and "quantity demanded" matter more than in the labor market. Demand, itself, may not have actually changed but quantity demanded may have changed greatly, resulting in a massive change in potential labor capital.

  2. Dismissing oil as "just energy" is disingenuous. Solar and wind cannot compete directly with oil, because oil represents energy storage, whereas solar and wind are energy sources. There is no direct swap; no matter how many acres of photovoltaic cells surround your house, you'll get nothing from them at night, and forget about mounting a turbine on your car.

    Furthermore, oil (and petroleum products in general) is stored energy which is (1) high-density, (2) reliable, (3) highly portable, (4) easy to use (in terms of building a motor), (5) (to date, at least) easy to obtain, and (6) largely free of toxins. Right now, all other forms of energy storage fail two or more of those tests.

    Yes, there are various schemes for green energy storage which could replace oil -- the most well-known being hydrogen fuel cells -- but these currently either require special conditions which do not hold in most cases (you can have energy generation during the night using concentrated solar thermal -- if you're willing to dedicate about three times as much land per kilowatt-hour to solar power as you do with photovoltaic), or are too tricky to be manufactured in bulk at the current state of the art, or both.

    Throwing more labor at the problem is almost certainly not going to help, unless by "labor" you mean "highly educated materials scientists and applied physicists", and even that isn't a guarantee. Manufacturing processes do not become better at a uniform rate, even when there are companies throwing lots of money and time into research.

    Take OLED screens, for example: there are at least two large multinational corporations pouring money into research (Canon and Sony, if I recall correctly), and with good reason -- whoever manages to get a manufacturing process which can turn them out at TV sizes without a huge defect rate is going to make a fortune very quickly, since they're dramatically better in a variety of ways than LCD flat panels and plasma, and are cheaper to manufacture, too. The laptop market alone would be huge, since OLED has extraordinarily low power consumption and an instantaneous reaction time (unlike LCD).

    But even after a decade, OLEDs larger than a few square inches are still so hard to make that for practical purposes they don't even exist, and small OLEDs are too expensive to compete with LCD at the low end.

    So you've started this post with an assumption which is effectively false for the foreseeable future.

  3. Thomas:: Even Adam Smith asserted that the fundamental component of any economy is labor.

    Indeed he did. Many people erroneously attributes this insight to Marx and call it a fallacy.

    The problem, both as he identified it and as it continues to exist today, is that there is and really can be no fixed metric for labor. Time isn't very useful as an hour spent digging a ditch, an hour spent designing a bridge and an hour spent composing a sonnet can't be reasonably compared.

    This is nonsense. Why shouldn't time be a useful metric? It's of course not a complete metric, but why should time spent digging a ditch, designing a bridge and composing a sonnet be utterly incommensurable?

    (Similarly, the total volume of an office building is not a complete metric of the building's value, but it's certainly a useful metric, even a fundamentally useful metric.)

    We know that a) we cannot dig ditches, design bridges nor compose sonnets without human labor b) ceteris paribus (and I hope you'll not deny the validity or ubiquity of c.p. in economics) increasing the amount of labor will proportionally increase the number of ditches, bridges and sonnets and c) to some extent we can transfer labor from one activity to another.

    More importantly this point has absolutely nothing to do with the thesis of my post, which is that capitalist economic crises are about failures of socially constructed demand, not friction or discontinuities in the allocation of labor.

  4. The Vicar: I don't "dismiss" oil as "just energy"; please apply enough charity and sensibility to distinguish between an example and an assumption. There's no controversy at all that human effort must be expended intelligently and in specific ways for it to have value. The point of the thesis is simply that economic changes require labor, labor can effect economic changes, and we have a lot of labor available.

    And, like Thomas, your observations are simply irrelevant to the thesis of my essay, which is about socially constructed demand, not the technological details of converting to a "green" energy system.

  5. Remember that this is not a textbook on capitalist macroeconomics, but rather a blog about philosophy, mostly the philosophy of communism.

    Like every theorist, including the authors of macroeconomics, I make simplifying assumptions. For example, it is not particularly relevant that manufacturing processes become better at a uniform rate; it is relevant only that in general manufacturing processes a) require human labor to become better, b) can become better with the application of human labor and c) ceteris paribus (and again in general) will improve in proportion to the labor invested in their improvement.

    I have written enough computer programs to know that the devil is in the details, and simply saying that we must invest a lot of labor hours to perform some task is not actually performing that labor, which requires skill, training, intelligence, creativity, discipline and talent. But just because there's enormous complexity in the details does not mean we cannot abstract those details away and make logically and empirically valid abstract generalizations about economics.

  6. Like every theorist, including the authors of macroeconomics textbooks...


Please pick a handle or moniker for your comment. It's much easier to address someone by a name or pseudonym than simply "hey you". I have the option of requiring a "hard" identity, but I don't want to turn that on... yet.

With few exceptions, I will not respond or reply to anonymous comments, and I may delete them. I keep a copy of all comments; if you want the text of your comment to repost with something vaguely resembling an identity, email me.

No spam, pr0n, commercial advertising, insanity, lies, repetition or off-topic comments. Creationists, Global Warming deniers, anti-vaxers, Randians, and Libertarians are automatically presumed to be idiots; Christians and Muslims might get the benefit of the doubt, if I'm in a good mood.

See the Debate Flowchart for some basic rules.

Sourced factual corrections are always published and acknowledged.

I will respond or not respond to comments as the mood takes me. See my latest comment policy for details. I am not a pseudonomous-American: my real name is Larry.

Comments may be moderated from time to time. When I do moderate comments, anonymous comments are far more likely to be rejected.

I've already answered some typical comments.

I have jqMath enabled for the blog. If you have a dollar sign (\$) in your comment, put a \\ in front of it: \\\$, unless you want to include a formula in your comment.

Note: Only a member of this blog may post a comment.