Underworld Economics, Cleaned up and Formalized

Peter Dorman has a great post up explaining why market economies have tendency towards underconsumptionism, a position which Keynes called "underworld" economics, but which he identified as being closely related to his own thinking.

Dorman talks specifically about the problems with Walrasian price setting, and suggests that in the real world firms set quantities and compete for customers on price. He loosense utility maximization assumptions about consumers as well and suggests that if consumers have loyalty to firms that satisfy their quality requirements, firms will invest in more production as way to maintain customers. Dorman writes "This fits with the literature in marketing, which stresses that a sale should always be seen as the opening to future sales and therefore worth a much greater investment than it would justify from a myopic perspective."

One of the most interesting points that Dorman makes is connecting this argument to the work of Janos Kornai. I first encountered Kornai in the way that I think most people did - as a critic of planned economies in a discussion of comparative economic systems. What a lot of people forget is exactly what Kornai's criticism of planned economies was - the idea was actually not that central planners regularly make disastrous "market process" calculation mistakes (to borrow an Austrian phrase) - it was that planners deliberately underpriced their goods. Central planners, Kornai argued, are price-setters whereas market economy firms are almost always quantity setters and price takers. The result was the socialist "shortage economy" - and the flip side is that the market economy is a "surplus economy". That's not that bad of a problem to have, of course! In all my concerns about demand deficiency, you never see me saying "man - we'd all just be better off under central planning", after all. But it does shed light on the economic problems we do face, which is overproductionism/underconsumptionism to put it crudely - and employment as a function of effective demand to put it a little more respectably.

And it is an interesting point that Kornai makes about central planners, isn't it? I don't even know if I would have been that radical before reading this post. If, as Hayek or Mises contends, the primary problem is a socialist calculation problem, then wouldn't we expect to see chronic oversupply - full warehouses and overflowing shelves - as often as chronic shortages in socialist economies? If it's just a miscalculation issue, why the observed bias towards shortages? The traditional SCD logic (in which I side with Mises and Hayek, don't get me wrong) doesn't seem to be able to explain this feature. Kornai can explain that, and can also explain the struggles of market economies.

A little while back, Jonathan Catalan blogged on overproductionism here.

Also, I suppose worth noting, H.P. Lovecraft and Bertrand Russell were fervent adherents to the idea of overproductionism - and I've found at least one letter of Lovecraft's and an essay of Russell's that specifically identifies underconsumptionism as a problem (usually you find that the overproductionist variant dominates in the lay literature - underconsumptionism is largely restricted to economists, I've found). I've gotten the impression that overproductionist concerns were very, very common in the early part of the twentieth century (Albert Einstein made the point at one time as well) - which is interesting because you really don't hear the idea voiced among non-economists these days at all.