How Capitalism Works (4): Anarchy of Production

IN AN EXCHANGE economy control over the use of the means of production is scattered among thousands of profit-seeking enterprises with no central co-ordination of decisions about the amount and the kind of wealth to be produced. Anarchy inevitably prevails.

For a group of enterprises to make profits, its total productive capacity and output have to be restricted to the level at which the interaction of supply and demand will give a price high enough to cover both the cost of production and a margin for the average rate of profit. The chaotic way in which decisions about production are made means that it is sometimes difficult to restrict productive capacity and output to this level.

In agriculture in particular over-supplying the market is a chronic problem. This is due partly to lack of control over the process of production (essentially the natural process of growth) and partly to the large number of small individual producers who still survive in this sector of the world exchange economy.

Once a market has been over-supplied, the immediate problem is how to offset the fall in prices which threatens the profits of the agricultural enterprises and the personal incomes of the individual producers. The immediate answer is to destroy the excess market supply, and every year fruit is dumped or milk is poured away or vegetables ploughed back into the ground or butter is fed to pigs. This is often mistakenly said to be the result of “overproduction”. It is due rather to more having been produced than can be sold at profitable prices. “Overproduction” is quite the wrong word since frequently there are people who desperately need the goods (although unable to pay for them): “market oversupply” would be a more accurate description.

The long-term solution is just as restrictive. The State steps in and takes measures aimed at restricting not simply output but productive capacity as well. The most notorious of these policies is that adopted in America in the 1930s under which farmers are paid not to grow food. The Common Market now has a similar policy and has paid farmers to slaughter their cattle and pull up fruit-trees as well as to curtail farm production.

The States which govern the areas where food and agricultural raw materials are produced have also taken steps to combat the problem of chronic market oversupply. Typically they operate a quota system under which each State undertakes to restrict production within its frontiers to an agreed level and to destroy any amount produced in excess of this quota. This is why recent years have seen public bonfires of cocoa or coffee in poverty-stricken African states like the Ivory Coast, Ghana, and Kenya. When in 1968 the main wheat-producing States were faced with two bumper harvests on the run, they agree to restrict production. Canada’s contribution was to pay its farmers to grow virtually no wheat at all during 1970.

Not that these restrictive practices were intended to secure monopoly profits. They aim merely to allow agricultural enterprises to make the average rate of profit (or the individual producers to get a very modest minimum income). Their significance lies in the fact that they dramatically show up the way in which the operation of the exchange economy restricts productive capacity even when human welfare demands it be increased.

Industry too destroys productive capacity in order to restrict output, as when a market is contracting. States then pay Industrial enterprises to destroy their machinery and equipment or themselves buy up (nationalise) their assets and arrange for the allegedly excess productive capacity to be destroyed. Generally speaking though industrial enterprises themselves manage on their own to restrict productive capacity and output to the profitable level. The problem of chronic oversupply of the market does not arise because the extra workplaces or the extra equipment that might produce the “surplus” are nor built in the first place.

This is the important point. The problem is not so much excess market supply as excess productive capacity. Excess market supply in agriculture and industries faced with a shrinking market is only a symptom of the fact that productive capacity there is able to supply the market with more than will result in profitable prices.


The problem of matching production with market demand is not confined to particular markets: it arises also for the exchange economy as a whole. Here again in the long-run the competitive struggle for profits does result in the two being matched, but at the expense of short-term fluctuations. These have been features of the exchange economy since the end of the 18th century and have been called “the trade cycle”, “the industrial cycle”, “the business cycle” and “the boom slump cycle”.

The regular occurrence of “slumps”, during which production is well below the existing productive capacity — the notorious paradox of poverty in the midst of plenty — has led some economic thinkers to suggest that built-in to the exchange economy is a permanent lack of market demand or, as they often put it, “a chronic shortage of purchasing power. Slumps arise, in their view, because in the long run total market demand is not large enough to keep the existing productive capacity fully used. This amounts to saying, not simply that the need to sell products on the market at a profit restricts the productive capacity of society (a valid charge) but to saying that the system also has a permanent difficulty in selling at a profit even the wealth it does allow to be produced.

Whether or not the symptom allows the productive capacity it has created to be more or less fully used, it is guilty of not expanding its productive forces fast enough.

One lack-of-market-demand theory says that because prices are composed of wages plus profits and because market demand is composed only of wages then there must be a chronic lack of purchasing power. It is quite true that the wages paid to the workforce can never be enough to buy the whole net social product, but they do not have to because what wage-earners do not buy can be bought by enterprises out of their profits (whether it always will be is another matter).

The wealth which enterprises buy is generally quite different in character from the wealth wage-earners buy. Enterprises buy new raw materials, new buildings, and items to use the following year to produce more new wealth. Wage-earners buy food, clothing and shelter for immediate consumption. This distinction is between producer goods and consumer goods, “investment” being the act of buying producer goods and “consumption” the act of buying consumer goods.

Early critics of the capitalist economy failed to see the real nature of investment as the purchase of producer goods. They saw, correctly, investment as a deduction from consumption but made the mistake of assuming that the level of market demand was determined by the level of consumption. If you believe this, then it follows that the act of investment inevitably leads to a state of general market oversupply: the increased output brought about by investment faces a market reduced by the very act of investment! This theory of course makes the growth of the profit-motivated economy impossible unless markets outside the system can be found, and this indeed was how these theorists did explain growth.

Early defenders of the capitalist economy could see these critics were wrong, but they went to the opposite extreme and claimed that total market demand would always equal actual productive capacity. They conceded that productive capacity and demand in particular markets could get out of line but vehemently denied that this could happen to the economy as a whole. This denial was maintained in the face of the regular occurrence of periods when productive capacity was not fully used.

This view is known, somewhat inaccurately, as “Say’s Law” (after the early 19th century French economist I.B. Say who was among the first to suggest something like it). It implies that the money obtained from selling one product is immediately spent on buying another one. But what if one seller decides not to spend the money he gets from a sale? Would this not interrupt the whole process?

Say’s Law did not take into account the fact that money could be hoarded. But once “this possibility is accepted then so must the possibility of total market demand being, temporarily at least, below actual productive capacity: general market oversupply leading to idle productive capacity becomes a theoretical possibility. Hoarding must not be confused with saving. When a person hoards money he takes it right out of circulation and holds it idle. Saving is defined rather as lending the money, either directly or through the banking system, to someone else to spend. Since (if there is no hoarding) the money saved, or not spent on consumer goods, must be spent on producer goods, then savings and investment are equal. From this angle, the mistake the early lack-of-market-demand critics made was to assume that saving and investment had the same economic effect as hoarding.

But why should anyone want to hoard money and not use it either to buy consumer goods or to bring him an income as interest? Why indeed should any person? Wage-earners, however, are not the only buyers since enterprises also have money to spend. Most of the profits enterprises make are invested, spent on buying producer goods for future production. But, according to the law of profits, enterprises will only invest in future production if they think that they will make enough profits from selling the products. If they think that the chances of profit-making are too low then they apply the rule “no profit, no production”. But, in this event, what happens to the profits they made the previous year? They are to all intents and purposes hoarded by being held idle as cash or maybe lent for short intervals at a low rate of interest.

This is how in the real world a state of general market over-supply and under-used productive capacity can come about. If, because of the slim profit prospects, enterprises hoard rather than invest their previous profits then total market demand will come to be insufficient to fully use the existing productive capacity.

Enterprises tend to judge the future rate of profit by the existing rate. Next month, in the context of explaining slumps, what might cause the rate of profit to fall will be examined.


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