General Overcapacity Cannot Exist 12 comments
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One of the funniest words in the lexicon of business is "overcapacity".
Here's Bloomberg:
China’s economic slowdown is deepening, with overcapacity in almost all industries, and won’t bottom out until after the first quarter of next year, two senior officials said today.
Think about that: "overcapacity in almost all industries". Perhaps we exist in a more enlightened world than I ever imagined. I've always thought that human want for material goods was basically unlimited. Apparently not! We have enough, not just here in the once gluttonous U.S. of A., but everywhere. All of the nearly seven billion humans of planet Earth have no use for anything more than they already have. Subsistence farmers in Africa prefer to live as they do, because it plays charmingly in National Geographic. If you offered them 10 million Yuan and a shopping trip, they'd shyly refuse.
The world does not now, and never has had, a general problem with "overcapacity". It might be sensible to talk about overcapacity with respect to a particular good or service in a particular setting. Maybe five Starbucks (SBUX) Cafes really are too many for one city block. But as a macroeconomic phenomenon, overcapacity is bullshit. Capacity can be misaligned — there might be too many sock factories for too few shoe factories. But there can be no general overcapacity, only under-utilization.
We, collectively, have not figured out a means of addressing an incompatibility between the incentives by which we encourage production and the means by which we distribute it. Human effort is driven by positional as much as material incentives: We measure ourselves against one another. Two centuries ago, a person could be rich with no running water, electricity, or internet. But wealth was still wealth, and people worked just as hard to be rich then as now. But since wealth is positional, people's desire for wealth may far exceed their intention or ability to consume. When great wealth is earned by contributing to production, this leads to a surplus, which seems like a good thing, but creates the "problem" of excess capacity. The obvious solution is to redistribute claims on production, so that those with unmet wants make use of the excess. But doing so reduces the differences in station that inspire Herculean efforts to produce, and provokes conflicts over who gets what.
The macroeconomic stories of this decade have all been about squaring this circle: Rather than redistributing claims outright, we adopted the fiction of trading present goods for future claims. The ambitious grew wealthy by accumulating claims on the future of the less ambitious, in exchange for which the less ambitious (and sometimes very distant) consumed present production, and demanded more. Entrepreneurs could measure their position against their fellows by the quantity of their claims. Others could consume in proportion to their ability to manufacture claims that entrepreneurs would accept, that is, they could consume what they could borrow. But high quality claims on future wealth are in reality very scarce. An economic system that depends upon ever expanding claims on the future in order to provide current incentives to produce can not be stable. Once the "wealthy" learn that many of their claims are worthless, the system falls apart. The less-wealthy have no means of consuming, as new claims are shunned. Owners of capital gain nothing but bear costs for maintaining productive infrastructure. "Excess capacity" appears.
There is no iron law of economics, no physics of resource constraints, that prevents us from using all the productive capacity we have ever developed. Our problem is distributional and organizational: How can we match potential consumers with capacity (broadly defined) in a way that maximizes current well-being, and that offers sufficient information and incentives to inspire and direct future production? That's not an easy problem. In fact, it's a deep problem, philosophically and ethically, the substance of which is mostly neglected or assumed away by modern economics. Nevertheless, it is the real problem, not "overcapacity". The world still needs more, and better. We should be careful of what we destroy because, for the moment, it seems "uneconomic".
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This article has 12 comments:
Keeper. Thanks!
nobody is buying at the price we want to sell at.
Perhaps overcapacity implies that a certain form of manufacturing capacity had been expanded on the premise of consumption of natural resources at a rate exceeding the sustainable.
Or, it implies that the potential consumers of this form of output cannot produce something of equivalent value.
I am deleting you from my SA watchlist. The global overcapacity of economic hooey and shortage of common sense inspired me to cut spending and conserve my remaining intellectual cash. I'm certain you can find plenty of hungry readers in Africa whose appetite for flattery and deceit knows no limit. Have you considered a job in public service, say minister for education in Nigeria? Your thesis of redistribution would be very well received in the Niger Delta. There's enormous opportunity for propaganda growth in Chad, DR Congo, Sudan, Zimbabwe and the goldfields of South Africa.
But why stop there? You could franchise the concept of "unlimited desire for weath" and help Hugo Chavez redistribute claims on production in Venezeula. Raul Castro would gladly pay you Tuesday for a whistlestop lecture today if you don't mind being paid in kind with hot air on Radio Havana.
But the big prize is China. I know it's an awkward proposition. You'd have to learn Mandarin. Lord knows, I couldn't do it. I tried to learn Dutch when I was living in Holland. Didn't have enough phlem to pronounce "graag" or "gooiemiddag." Some people just aren't talented enough to succeed in life on life's terms linguistically. I also lack the ability to play the oboe, perform neurosurgery, pilot an F-16, or bail out General Motors Acceptance Corporation. With so many depending on the Chinese and Arab oil exporters to do these things for us, obviously it's tantalizing to swap some hooey for real goods. Our propensity to consume certainly poses no barrier to one-way trade, although we do have a problem currently that would be exacerbated by cranking up free lunch. There's a mountain of empty cargo containers in New Jersey already. Maybe the solution is to export dead laptops and surplus ringtones to Iceland.
It's been wonderful having this chat with you. I rarely have a chance to flex my comedy writing skills on Seeking Alpha, which used to be a place to read charts and ponder investment opportunities. If you have spare moment or two, while you're busy enlightening the Chinese Communists, please do remember that the US labor movement is in a terrible pickle, and your theory that "overcapacity is bullshit" could save the day in Detroit.
:P
On Dec 14 08:23 PM Alan von Altendorf wrote:
> Dear Comrade Waldman,
>
> I am deleting you from my SA watchlist. The global overcapacity of
> economic hooey and shortage of common sense inspired me to cut spending
> and conserve my remaining intellectual cash. I'm certain you can
> find plenty of hungry readers in Africa whose appetite for flattery
> and deceit knows no limit. Have you considered a job in public service,
> say minister for education in Nigeria? Your thesis of redistribution
> would be very well received in the Niger Delta. There's enormous
> opportunity for propaganda growth in Chad, DR Congo, Sudan, Zimbabwe
> and the goldfields of South Africa.
>
> But why stop there? You could franchise the concept of "unlimited
> desire for weath" and help Hugo Chavez redistribute claims on production
> in Venezeula. Raul Castro would gladly pay you Tuesday for a whistlestop
> lecture today if you don't mind being paid in kind with hot air on
> Radio Havana.
>
> But the big prize is China. I know it's an awkward proposition. You'd
> have to learn Mandarin. Lord knows, I couldn't do it. I tried to
> learn Dutch when I was living in Holland. Didn't have enough phlem
> to pronounce "graag" or "gooiemiddag.&... Some people just
> aren't talented enough to succeed in life on life's terms linguistically.
> I also lack the ability to play the oboe, perform neurosurgery, pilot
> an F-16, or bail out General Motors Acceptance Corporation. With
> so many depending on the Chinese and Arab oil exporters to do these
> things for us, obviously it's tantalizing to swap some hooey for
> real goods. Our propensity to consume certainly poses no barrier
> to one-way trade, although we do have a problem currently that would
> be exacerbated by cranking up free lunch. There's a mountain of empty
> cargo containers in New Jersey already. Maybe the solution is to
> export dead laptops and surplus ringtones to Iceland.
>
> It's been wonderful having this chat with you. I rarely have a chance
> to flex my comedy writing skills on Seeking Alpha, which used to
> be a place to read charts and ponder investment opportunities. If
> you have spare moment or two, while you're busy enlightening the
> Chinese Communists, please do remember that the US labor movement
> is in a terrible pickle, and your theory that "overcapacity is bullshit"
> could save the day in Detroit.
>
> :P
Unfortunately, the present system has so many conflicts of interest, cronyism, and inequalities built into it, and so many people 'making money' for being dishonest/crooked (like Paulson, Madoff, and thousands of others on WS) or else by taking advantage of legislated monopolies or economic distortions, that the system does a pretty poor job of allocating the wealth where it belongs.
There is one little problem with that. It's called the finite carrying capacity of the earth. As we produce and consume without limit, we are trashing our planet at a disastrous rate. Farm land, clean water, fish in the sea and animals on the land -- we are destroying them with little regard for the future. If we don't show some respect for the environment that sustains us, we may find that it won't.
The biggest bubbles are human population and human consumption. Want to bet those can't pop?
I think Mr. Waldman is making a point about a simple but fatal arithmetic problem involving incomes and prices that is routinely ignored or glossed over. To simplify:
Let's say Acme Mfg. & Distribution Inc is America's only employer and everybody (except government employees) works for Acme producing all the goods Americans want to buy. Acme is "the economy".
All 'primary' incomes earned by Americans are paid out by Acme as salaries, wages and payments to suppliers. Taxes take 20% which is paid out to government workers and various welfare recipients. So everyone in America has some money to buy the goods they need, and all those goods have been produced by Acme at a cost of $1 billion.
Acme thus "distributes" a total of $1 billion into the economy, and to keep this scenario simple we will ignore any money people might have had before they earned these incomes.
To make a 5% profit on the sale of its output Acme must sell all the goods it produced for $50 million more in money than the $1 billion of money it distributed into the economy.
It has to collect every dollar of the $1 billion it paid out just to break even. But the extra $50 million it needs to collect as profit was not distributed into the system as incomes (or dividends or profits) so it does not exist in the economy.
That's the problem. Business needs to collect more money out of the economy than it puts into the economy, in order to make a profit. At a 5% markup, the total prices in the economy exceed the total incomes in the economy by 5%. Acme cannot sell ALL its goods at a 5% markup because there is no other player in the system to inject the additional 5% of money. There are 5% more total prices in the economy than there is money to pay those prices.
The only way to get additional money is for someone to borrow it and go into debt, and when that money is taken out of the economy to repay the debt you're back to "excess" goods for sale at prices that make it worthwhile to stay in business.
It's a zero sum game. There is no magical source of additional non-debt money flowing into the system. Government can only spend money it taxes; or money it borrows today then taxes tomorrow. Total prices must exceed total incomes if business is to earn a profit.
"Overcapacity" is simply the excess of profitable prices over the total amount of people's incomes. If Acme sells $1 billion of goods from its round of production at 5% markup then Acme will have all the economy's money and there will be unsold goods on the shelves but nobody has any money to buy them.
With its original $1 billion back Acme can engage in a 2nd round of production which will produce an additional 5% 'excess' of goods that nobody has any money to purchase.
Each new round of production adds an additional 5% to the gap between the total prices of goods for sale and the total money available to pay those prices.
Ever increasing consumer debt can provide the needed money to consume the goods, but if people use the borrowed money to buy the goods they will never be able to repay their loans. Sooner or later the debt expansion has to stop, as has been made clear recently, so borrowed money only temporarily disguises this problem.
Acme's workers and suppliers and owners made all those goods themselves, but they collectively weren't paid enough income to buy them all. Goods that people want sit on shelves because the people who made them cannot afford to buy them.
Acme cannot make profit. It can at best break even. Who, precisely, is supposed to be the beneficiary of this arithmetically challenged economy?
I scarcely know what to say in reply. A single national employer without competitors is communism or fascism depending on which corporate slogans and songs are imposed by the Thought Police.
Why is it my job, all of a sudden, to explain capitalism on SA?? Jeez.
Subsistence farming and handicraft means that you produce enough to feed and clothe your immediate family or commune. Smart people save enough seed corn to plant next spring, and try to pair the best livestock to increase the herd, etc. Maybe there's a barter arrangement between tradesmen, planters and a couple kooky inventors like Ben Franklin.
Capitalism refers to capital goods, a harvester that no individual farmer could afford to buy or build. When you get on a jet airplane, you haven't bought it -- haven't even paid a meaningful fraction or what it took to engineer and assemble. Capitalism doesn't work without credit. You can't build a computer with seed corn and horseshoes. I don't even think you could build a water tower or septic tank with "savings" in the material sense of surplus leather for instance.
Trade, speculation, banking and credit arise from the need to facilitate exchange and bridge the gap from present to future consumption. Money is a token given and received in expectation of delivery at a future date. Even in your impossible world of a single national producer, whatever "money" they pay out in salaries and graft presupposes that those pieces of paper or metal coins can be redeemed for goods at a later date, even if the interval is only a week or two, living paycheck to paycheck (like most of are in reality today).
Borrowing and lending does not change the game. The only difference between cash and credit is duration to maturity. Both are liquid, and sensible people don't pay much attention to M1 cash or M3 deposits. Think "total liquidity" (L) -- all the instruments that mark to market and can be freely exchanged, including stock certificates and derivatives.
Individuals have different skills, abilities, needs, ambitions, and degrees of risk aversion. Some need cash today. Some are bright enough to save for the future. A few are entrepreneurial, risking their reputation and pocketbook on something new.
Overcapacity and shortage are part of the business cycle, by which we mean a somewhat predictable overshoot to adopt or popularize something new, like railroads in the Golden Age, radio in the Roaring 20s, computers and SUVs in the 90s.
Please don't confuse government spending and borrowing with capital formation. Our problem today has nothing to do with overcapacity or financial leverage or lending bubbles. It's easy to say that capitalism is unworkable. Unless you ask yourself what government wrought.
I think your analogy breaks down for 2 reasons:
1) Failure to acknowledge that previously non-existing wealth is created by combining resources and labor to produce tangible goods and services. Do businesses (besides the big 3) spend $1B to produce $1B in revenue? Of course not. They might spend $800M (in salaries, costs, everything) to produce $1B in revenue. The difference (profit) is the value they have added to the world, as judged by their customers. In the long run, output is greater than input.
2) Not assuming that these profits are then spent by their owners to become income for someone else who in turn, has created more value than he consumed. It is profit, not debt, that is recycled into even more production by the economy. That's why we have so many tangible goods and services available to buy with our profits/salaries. We don't just go to work and bring home debts, we use money as a way to barter our labor for someone else's labor.
On the issue of overcapacity, it exists wherever costs exceed the revenue that it can generate. Under this condition, businesses shut down. Theories about human greed or worldwide human need are irrelevant to the question about whether profit can be made or whether overcapacity exists.
Abuse of the system, especially when involving deliberate deceit, is.