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 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 underutilization.

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 person. 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".

Update History:
  • 13-Dec-2008, 2:50 p.m. EST: I've fixed some poor writing in the paragraph on positional incentives and bit about using future claims as a fudge to redistribute present consumption. The rest of the poor writing remains unchanged.
Steve Randy Waldman — Saturday December 13, 2008 at 1:16pm permalink
Thomas Barker (www):
Since we're not exporting anything useful to China (unlike Germany or Japan), the withdrawal of our demands for iPod's aren't going to screw anything up too badly for them. The Chinese gov. can just take the export subsidy $'s and spend them on domestic welfare.

There seems to be general fear that China will ape Japan's expansionism if world trade slows. But China is reasonably self-sufficient in raw materials, energy, food, etc. Britain on the other hand ... :-D
12.13.2008 3:48pm
M.G. in Progress (mail) (www):
Marx used to call it overproduction crisis.

There is no point in maximizing current individual well-being. Perhaps Americans simply realize that a SUV does not add too much well-being, particularly if you buy it on debt; when the bill comes you realize the overproduction crisis of automakers. Inequality rise is the real problem and the Gini index is on the rise in China as well...
12.13.2008 5:35pm
Thomas Barker (www):
Depends on why the inequality is there. Few would begrudge the people who eventually cure cancer life swimming in women &wine. Most people only got angry about IB bonuses *after* their 401k disappeared.

If we had bred an intellectual race of financial geniuses who could peer into the future with the power of their minds, they'd be well worth the money :-D
12.13.2008 9:37pm
Benign Brodwicz (mail):

Jesus was not so dumb when he said the poor will always be with us. Nor was Solomon when he wrote that the person who oppresses the poor insults his own Maker.

Where is a value-driven economics for the Western world?
12.14.2008 11:54am
Phillip Huggan:
A similiar problem is that the means of production aren't connected well to what actually makes Americans happy, vs what is marketed to them to make them happy.
A whole bunch of credit went into homes post 9-11, and a whole bunch of wealth went to the rich. A recent survey said Americans with homes (assume mortgages) were less happy then those without (I assume renting or apartments). Of course home ownership isn't bad, and those unhappy are probably so because they divert wealth from other utilities to pay for homes out of their league. But it seems like no one has educated Americans how to elect leaders that give them what will make them happy.
There is a disconnect with the status arms race, but there is an even more fundamental disconnect with what is produced even before the arms race. If you told Americans they could have a home and know their children will live to 80, or rent an apartment and know their children will live to 100...I'm no parent but I'd know my choice. Just one example. Another is choosing really rich people, or choosing the ability to retrain and rechoose careers as an adult. If a system is making rich people richer, the rich won't alter it regardless of any efficiency analysis presented; will use media to distract.
12.14.2008 3:02pm
Eric Pederson on Economics & Overcapacity (mail) (www):
Overcapacity only makes sense in its local context (I have an overcapacity of food on my plate at this meal) - but let's accept the challenge to not excuse ourselves with that context, like the old admonition "Eat your food, there are starving people in (China, India, Africa, Detroit)"

The wealthy who have followed their high motivation to rise above others have abundance, while others have scarcity - what do to?

If we remove the motivation to rise above others, we likely lose the abundance; this is what is experienced in large communist entities (countries rather than monasteries). So how do we combine better distribution of production with high output?

Motivation is the key, people must be motivated to acheive high production, whether we term it overcapacity or not.

Perhaps an answer would lie in raising social altruism to a key determinant of social status. If one's station and standing were dependent on how much one was providing for others, the incentives to produce would be in better alignment with the needs of the world populace.

Whether this is feasible with our species, I cannot say, but why not encourage social movement in that direction?
12.15.2008 1:06am
Naile (mail):
I would recommend the Gridlock Economy by Michael Heller about the problem of underutilization. His book explains the "tragedy of anticommons" and demonstrates ways to recognize this concept which is not as easy to spot as the more familiar "tragedy of commons and overuse".
12.15.2008 12:34pm
Steve Roth (mail) (www):
Expanding the Earned Income Tax Credit is high on my list. Currently provides essentially nothing if you're single.
12.15.2008 3:43pm
RueTheDay (mail):
Great post Steve. I too shudder when I hear the word "overcapacity". However, please recognize that there has been a debate going on about this topic (under the heading "the possibility of general gluts" AKA "the debate over Say's Law") going on in the field of economics for well over 200 years. Smith, Ricardo, Malthus, Mill, Sismondi, Senior, Marx, et al argued over this back and forth for generations. It's what led Keynes to claim that his economics represented the definitive break from classical economics.

In a hypothetical barter economy, there can be no such thing as a general glut. Every act of production yields the means by which an equivalent act of consumption can occur. You can have an imbalance between supply and demand in any particular market, but not in the economy overall. Say's Law holds. A monetary economy is much different - like Cyndi Lauper used to sing, "money changes everything". As Keynes pointed out, people desire to hold money not merely for the purpose of conducting transactions, but also as a precaution against an uncertain future. An excess demand for money (liquidity really) then translates into an equivalent insufficient demand for goods and services overall. This is just another way of looking at the paradox of savings. Labeling it "overcapacity" is misleading. It's not that there's too much capacity; it's that there is insufficient purchasing power to consume the products of the existing capacity.
12.15.2008 7:03pm
reason (www):
Great post. I'm with Steve Roth, but I like to call it National Dividend. That and investment in the infrastructure (and regulation) needed to create more quality urban neighbourhoods (everywhere) to keep the price of land down (LVT could help as well).
12.16.2008 5:48am
M.G. in Progress (mail) (www):
What about overproduction of money or better over cration of money? Maodff's Ponzi scheme is one aspect of it. The other one was explained by Greenspan who said in his testimony:"excess of global intended saving over intended investment. This configuration is equivalent to an excess of the supply of funds relative to the demand for investment. What is unclear is whether the excess is due to a glut of saving or a shortfall of investment.. Basically there are some surpluses that cannot be allocated productively and they end up in Ponzi Finance. It is the case that if you have overcreation of money you also end up having overcapacity. The equation can be solved with reduction of inequality and redistribution. This is what I think here:
12.16.2008 3:47pm
"If we remove the motivation to rise above others, we likely lose the abundance; this is what is experienced in large communist entities (countries rather than monasteries). So how do we combine better distribution of production with high output? "

I've often wondered if that's really true. Or were we fed that as propaganda so often that we no longer question it?

Perhaps it was just poor planning, the arms race, corruption that screwed things up.
12.16.2008 6:44pm
Mercutio.Mont (mail):

I'm going to throw the Equivocation flag here.

Your definition of overcapacity is not the same as the definition of overcapacity used in the Bloomberg article.

The Bloomberg's definition of overcapacity (if I may put words in their mouth) is roughly as follows: Capacity which puts so much product on the market that said product can no longer be produced at a profit is excess capacity.

Further reading on the fallacy of equivocation can be found at Wikipedia:
12.16.2008 7:28pm
"How can we match potential consumers with capacity (broadly defined) in a way that maximizes current well-being ?"
The problem is ill-posed : well-being (or happiness, or utility whatever you want to call it) is not an additive quantity between Person A and Person B.
To add up Person A and B well-being, you need to find an exchange rate. Unless one in a non free society (where Person A decides what makes Person B happy), the exchange rate can be found only through MUTUALLY ACCEPTED transaction. If Person A and Person B don't agree on the term of exchange (for instance Person A can produce a car and Person B can produce 100 liters of milk), A and B have the "capacity" to produce the goods to could be exchanged, but nevertheless won't.
This is the essence of "overcapacity" and there is nothing wrong with that : To be capable of something doesn't mean that you should do it.

This is not a neglected problem of economics. On the contrary, it is the essence of economics !
12.17.2008 6:02am
reason (www):
what rot!
You are making the common mistake of confusing the map with the territory.
The non-additivity of utilities is an ASSUMPTION as part of particular flavours of economic theory. And it is an assumption that in my view is made specifically with the aim of protecting the status quo.

Making very conservative assumptions of diminishing utility of money and approximately equal importance and scale of utility between individuals, you can show that static redistribution increases overall utility (ignoring dynamic effects). And if you take into account positional externalities, then that really blows it out of the water.

Taking the initial starting point of wealth distribution (including human capital however defined) as a given and saying that voluntary exchange will make a pareto improvement is not controversial, but it also doesn't take you very far.

To say that all people are better off producing absolutely nothing rather than making an exchange that doesn't suit one of the parties in the circumstances is classic "reductio ad absurdum". To believe it is idiotic.
12.17.2008 10:58am
reason (www):
Mecutio Mont
I don't think you have understood the point of Randy's article. It wasn't an attack on the article, it was if you like an intellectual aside, based exactly on the ambiguity in the word overcapacity. He would prefer they use a different word.
12.17.2008 12:01pm
Metatone (mail) (www):
The key unsolved problem is that our system rewards owners of capital more strongly than anyone else.

If you have money, you can get anything you want. If you don't... well you can't have anything.

Large proportions of the world's population essentially have no money.

There is now the industrial capacity to produce more than the people who have money want. But why would anybody produce any more if they are not going to get any money for it?

That is what it means to say we have overcapacity.
12.19.2008 2:16pm
reason (www):
but the answer to that is easy. Tax and spread. (Or a genuine Ben Bernake helicoptor drop)! Its not difficult, it just needs someone to do it. And hell, negative income tax was an idea from the Daddy of all free market guru's Milton Friedman - it could even be made bi-partisen. So why hasn't it happened?
12.23.2008 8:43am
Gu Si Fang:
"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."

Yes, there is. Operating the infrastructure which was built in the past requires present resources. When those resources are more urgently needed elsewhere, the infrastructure are best left to rot away. The question then is : why were they ever built? Why were these errors made? There might be many factors, but one of them is monetary expansion. The credit and asset bubble has resulted in unsustainable expectations and has misdirected investments. This is the essence of the austrian business cycle theory. While businesses often make errors, only during a credit bubble are all errors aligned so that they constitute a "cluster of errors" instead of cancelling each other out.
12.24.2008 3:16am
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