Consumer-Led Recovery

This post will cross at a different angle, ground covered already.

The belief is still currently widespread, and held by persons of influence in economic affairs, that a general increase in wages will boost the economy, i.e. increase the throughput rate and its derivative by increasing consumer demand.

As already discussed, this would apply to modern problems, for which it is quite inappropriate, the solution that was correct for the depression of the 1930s.

In a radio talk in Australia some years ago, the speaker said that the problem of industry and the economy at that time was not the cost of wages, or the cost of finance, the problem was lack of demand. That is, the ratio of spending in the economy was too low. Two hundred manufacturers had been asked “what single factor, if any, is most limiting your ability to increase production?” They did not say the cost of labour, the cost of finance, or the availability of materials. Over 90 percent of them said “Lack of Orders”. In the previous eighteen months the lack of orders had risen dramatically. It had been declining as a factor before then. Since then, the speaker said, lack of orders had been the main problem. He said that the aim of economic policy should be to increase incomes and that meant increasing disposable incomes for the economy as a whole and particularly for those unemployed.

This might be a case of getting a report of a symptom and ascribing it to only one possible cause, as though that cause were the only one. In this case it was the speaker’s preference.

“Lack of Orders” in the sense that orders are not sufficient to maintain full employment, would be the immediate cause of unemployment, the overt symptom of economic trouble, no matter what the particular nature of the trouble.

The important question is, what are the original causes of the lack of orders? Lack of orders is not an original cause; it is an effect, which in turn is the cause of subsequent economic effects.

In the Great Depression, lack of orders was in fact caused by insufficient consumer spending because too little money income was flowing into the wages channel. In the circumstances in which the radio talk was given, lack of orders was caused by purchasers not being able to afford the prices for all the wholesale consumer goods and producer goods that needed to be structured to maintain full employment.

Once again, this looked similar to the problem in the depression. The difference was that in this more recent situation, wages were a higher proportion of the price of goods and services than they were in the depression. One might think, all right, prices are boosted by wages, but so is spending power, in the same proportion, so there should be no downward pressure on consumer demand.

But it is not as simple as that. There is a kind of “multiplier effect” here, because the excessive wages boost prices at every stage of the process whereby goods become available for purchase. This process entails the extraction of wealth, the development and construction of industrial plant, the structuring of wealth into goods, transport to shops, and sale to consumers.

So one consumer only has one excessive margin of money wages to spend, but must pay prices boosted by more than one excessive wage margin.

Thus ratio distortion in the direction of too much money flowing into the wages channel exerts downward pressure on spending power.

One may ask, doesn’t this type of multiplier effect work in the other direction when wages are too small a fraction of money flow? Doesn’t the wage deficiency at every stage depress prices by several deficiencies, making goods easier to buy for each consumer suffering only one deficiency, thus boosting purchasing power?

The mistaken assumption behind this question would be that the effect of wages on prices is linear. The relationship of wages to prices is not linear. The boost to prices resulting from, say, a 10 percent excess of money flowing in the wages channel (though it would be virtually impossible to measure the actual amount of excess or deficiency) would be greater than the depression of prices resulting from a comparable deficiency of money flowing in the wages channel.

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