Wednesday, June 17, 2009

Too Much Capacity, Too Little Demand

Capacity Utilization reached a post World War 2 low in the United States in June. And the World Bank's chief economist recently warned "Significant excess capacity has been built up and unless this issue is addressed, we will face a deflationary spiral and the crisis will become protracted".

This indicates that unemployment has the potential to go significantly higher. And given the same statistical criteria, much of the world is in a similar situation. The car industry is most emblematic of this, with excess capacity existing in nearly every developed and developing country .

This should not be a surprise. Excess capacity relative to demand - overproduction or underconsumption - is a historical feature of capitalism. Private firms competing for profit get ahead of themselves in the battle for market share. Too much is built, creating too much overhead and debt. Workers are squeezed for profit, and demand retreats.

The current glut in capacity comes despite the growth of new markets in developing economies. But to date, these economies remain largely export oriented. The push to increase demand in developing countries represents an attempt to reduce worldwide excess capacity through increased aggregate demand. There are reasons this will be a difficult solution. Developing countries are competing with each other to support established export industries. The improved labor practices and wages that would increase domestic demand run counter to the ability of each country to compete and profitably support investment.

Left to its own devices, the market weeds out lower profit firms in favor of higher profit firms. Liquidation wipes out excess capacity, and the process starts anew. U.S. capacity utilization has peaked at a lower percentage for each business cycle since the end of the post World War II boom, meaning the system has not been fully cleansed. It was an anemic 81 % at the height of the Bush II recovery.

The liquidationist society is not a particularly enjoyable one to live in. And it is incongruent with elections and political power. No politician spends years moving into a position of power, only to throw it away on a 'necessary' recession. Particularly intense cycles can lead to dramatic social and political instability. People don't like losing their jobs, and in most cases - it seems rather arbitrary. An individual can be doing a good job at a poorly run company that goes bankrupt. They do not what to hear they are part of the majesty of 'creative destruction'.

Since the end of the post World War 2 boom, governments have prevented the full amount of 'necessary' liquidation to their domestic capacity, relying on bubbles, cheap credit, and deficit spending to float things along. All G7 governments now find themselves deeply in debt, making the traditional salves to the business cycle more difficult to apply.

To go with this, private capital has become more powerful and mobile then governments themselves. This makes it difficult to tax the great reservoirs of wealth that exist in the capitalist class, as done in the traditional liberal model.

The interplay of large public sector debt with mobile private wealth will exacerbate the economic problems associated with significant excess capacity. In terms of investment, it means bubbles and stampedes of speculation - as established sectors of the economy will have stagnant growth, and be unable to generate acceptable returns. Geopolitically, there will be increased tensions between nation states - as they attempt to foist the pain of 'liquidation' upon their rivals. Internally, each domestic ruling class will attempt to impose the cost of restructuring upon the general population.



1 "IMF Warns of Deflationary Spiral"
2 Federal Reserve Capacity Utilization Statistical Release
2 "There's no quick fix to the global economy's excess capacity" - UK Telegraph, Ambrose-Pritchard

1 comment:

The Arthurian said...

I like this old post, BP. Thoughtful. I like your attention to "the end of the post World War 2 boom."

You write: "The push to increase demand in developing countries represents an attempt to reduce worldwide excess capacity through increased aggregate demand."

Keynes wrote: "But if nations can learn to provide themselves with full employment by their domestic policy (and, we must add, if they can also attain equilibrium in the trend of their population), there need be no important economic forces calculated to set the interest of one country against that of its neighbours."