Chapter 5: Saturation Thesis

Outline:

1st The problem

2nd The Say's theorem

3rd The increase in demand for more free time

4th The saturation thesis in a narrower sense

5th The robotisation thesis

6th The stagnation thesis of Alvin Hansen

1st The problem

In the course of the history of economic doctrines, we repeatedly encounter the thesis that sustained economic growth would not be possible at all in the long term, since at least the market-based economic systems would inevitably head towards stagnation, which would ultimately be triggered because the people would very quickly reach a state of saturation. The growth process was abruptly interrupted because the demand for goods saturated was very soon and because the economic system then had to collapse due to a lack of demand. This stagnation then manifested itself especially in a too low demand for labour. The demand for labour was always induced by the demand for goods and if the demand for goods stagnated or even decreased, then the demand for labour would inevitably decline, with the result that more and more workers would not find a job anymore.

We encounter these pessimistic teachings as early as the time of the classics, with whom modern economic theory had begun in the late 18th century. At that time, people spoke of underconsumption theories and understood this to mean the thesis that the employment of all workers who were able and willing to work failed because the demand for goods was not sufficient to employ all workers due to a general saturation.

Even if this decidedly pessimistic view was not shared by the majority of the early classicists - at least Adam Smith, the founder of modern economic theory, developed a decidedly optimistic picture of the development possibilities of a free market economy - it was above all David Ricardo - also a main representative of the classical period - who described a dynamic model that likewise ended in stagnation. David Ricardo based this on the likewise very pessimistic population theory of Robert Malthus.

The theme of classical underconsumption theories was then taken up in the 20th century when John Maynard Keynes again attributed mass unemployment to a shortage in the demand for goods during the Great Depression of the late 1920s. However, while Keynes had seen unemployment primarily as a problem of the cyclical downturn, it was Alvin Hansen, a student of Keynes, who was convinced that in the late capitalist phase mass unemployment would also prevail in the long run, since a secular stagnation in the demand for goods had to be expected.

The stagnation theories listed here are only a few particularly extreme examples of a whole army of theorists who have conjured up the spectre of saturation repeatedly in the course of history. It was above all Joseph Alois Schumpeter who drew attention to this recurring tendency in his History of Economic Analysis, but who also pointed out that the temporary crises that occurred were always overcome and that these proponents of the various saturation theories simply lacked the fantasy to imagine that humanity would never be satisfied with what had been achieved so far and that the scarcity of goods would continue, although basic needs had long been satisfied, at least in the highly developed industrial societies. The expansion of production possibilities was always followed by the discovery of new needs.

Now, one can certainly not speak of these theories of stagnation, which were repeatedly dusted off, as being the only or even the most important ideas about how market-economy systems will develop in the long term. Quite in contrast to these theories of stagnation, on the other hand, there have always been future scenarios which, although they also believed they had to predict a collapse of the economic systems, attributed the collapse of the economic systems to an overly high demand for goods in the highly developed industrial societies. The market economy systems, so it was argued, would inevitably lead to an exploitation of natural resources with the result that future generations would lack the natural resources that were necessary for survival.

2nd The Say's theorem

In contrast to these decidedly pessimistic views of the future, however, the mainstream of classical economic theory was of the firm optimistic conviction that these crisis phenomena did not necessarily have to occur and that satisfactory results of the economic process could very well be achieved through the free economic order outlined by liberalism.

At the time of the early classicists, it was mainly John Baptiste Say who tried to prove that mass unemployment was by no means to be feared for the reason that the demand for goods was too low.

Jean Baptiste Say lived from 1767 to 1832 and was one of the main representatives of French classicism. He became famous primarily for Say's theorem, which is named after him.

The Say's theorem opposes the underconsumption theories according to which too little demand for consumer goods would cause unemployment. According to Say's theorem, too little demand for goods cannot explain general unemployment, since every supply created its own demand. However, Say does not deny the occurrence of mass unemployment, but he does not attribute it to a insufficient demand for goods, but to incorrect price relations, i.e. to control errors, in his theory of clogged sales channels.

The value of supply turns in fact completely into income and this in turn becomes completely demand, since savings are invested always. General unemployment can therefore only be explained by structural causes.

Let us look at the individual steps of this theorem more closely. The first step is to establish that all sales proceeds become income. We are not looking at a single enterprise here, but at a consolidated balance sheet of all enterprises. On the right side of the balance sheet in the upper part of the graph, we enter on the income side the sales proceeds, i.e. the value of the supply, which the sellers of the final products achieve. Here we have to consider that a part of these sales proceeds is needed to purchase semi-finished products and raw materials from other enterprises. Here, the expenditures of the final product enterprises coincide with the sales proceeds of the semi-finished product enterprises and raw material enterprises, so we can neglect these amounts in a consolidated total balance sheet.

The sales proceeds of the final product enterprises continue to be used to remunerate the purchased factors of production, wages are paid to the employed workers, land rents to the land owners and interest to the capital providers. The remaining sum from the sales proceeds flows to the entrepreneur as profit income. We can thus conclude that the entire sales proceeds sum becomes income.

Next, we turn to the use of this income. Income can be used for the purchase of consumer goods or can be saved. Both together correspond always to the total purchase sum. For the sake of simplicity, we will assume a closed economy without economic activity by the state.

The savings serve the enterprises to finance their investments, i.e. to purchase capital goods. Thus, not only the part of the income that is used for the purchase of consumer goods becomes demand, but also the savings sum is fully used for the purchase of investment goods.

However, this proves that all supply (sales proceeds) becomes demand, either as consumer demand or as investment demand. Which had to be proven.

How are the assumptions made here to be evaluated? The first step, the proof that the sum of sales proceeds becomes completely income for the final product producer, results from logical considerations. The profit of the enterprise (G) is defined in such a way that it corresponds to the difference between sales proceeds (P * X) and the remuneration of the production factors employed (E_F). The equations therefore apply:

G = P * X - E_F gives P * X = E_F + G

Let us therefore turn to the second step in the analysis of Say's theorem. The fact that a part of the income (E_F + G) is consumed and therefore leads to the demand for consumption goods is again the result of logical connections, whoever consumes goods must as a rule have bought them beforehand.

The second thesis, that savings are always fully invested, is to be assessed more critically. However, this assumption arises from the fact that during Jean Baptiste Say's lifetime, the predominant form of enterprise was the partnership and that its entrepreneurs had to raise the required capital from their own income in the form of savings, since the income of non-entrepreneurs was still too low to save larger portions of their income. The only reason to save was therefore that entrepreneurs needed capital for their investments. Entrepreneurs therefore only saved when they had a need for investment. Their capital needs could only be met through their own savings, not by borrowing on the capital market. In the time in which Say lived, it was quite true that almost all savings were used for the purchase of capital goods.

In the meantime, two major changes occurred in this question. On the one hand, corporations emerged which had such high capital requirements that the savings of the entrepreneurial owners were not sufficient and therefore additional capital had to be demanded on the capital market. On the other hand, the income of large parts of the population had risen so much in the meantime that non-entrepreneurial households were also able to save part of their income and offered these savings on the capital market.

Although savers and investors were no longer the same people, and although it was therefore to be expected that the aggregate savings sum would be larger or smaller than the aggregate investment sum, neoclassical theory continued to assume that Say's theorem remained valid, since the capital market now ensured that savings and investment correspond with each other in the state of equilibrium towards which a free market was automatically heading.

The free market mechanism would ensure that the interest rate would fall if there was an excess of savings over investment demand and that therefore simultaneously less savings would be created and more investments would be made. Similarly, if there was an excess of investment, the interest rate would rise and for these reasons savings would increase and investment projects would be cut. In other words, the neoclassics assumed that the market mechanism would automatically balance savings and investment.

Thirdly, one can of course also doubt whether consumption and saving constitute the only uses of income. Finally, one must assume that considerable parts of the income must be paid in the form of taxes. It can therefore be criticised that Say's theorem assumes a closed national economy without economic activity.

In response to this last criticism, however, it can be said that it can be very useful to deliberately disregard certain real facts in order to better understand complex interrelationships. Once the interrelationships have been correctly recognised on the basis of simple models, the unrealistic assumptions of the first model can very quickly be removed. It is easy to redefine Say's theorem in such a way that the most important results of Say's theorem can also be maintained for an open national economy with economic activity of the state.

Now John Maynard Keynes has indeed pointed out that Say's theorem was based on two unrealistic assumptions: Part of the savings would be hoarded, i.e. would not be passed on via the banks to the enterprises for investment. At the same time, even if the savings were offered on the capital market and if interest rates were lowered as a result, the willingness of enterprises to invest would not be expanded sufficiently. In times of economic downturn, in which consumer demand declines, surplus production capacities would arise and the enterprises would therefore have no reason to expand these production capacities through investments.

It is not the aim of this chapter to discuss the weaknesses and errors of this Keynesian doctrine. This has been done in other articles on my homepage. In the context of the saturation thesis discussed in this chapter, it is only important to point out that with Keynes, the reduced demand for goods is just not explained by a saturation of consumer demand, but by deficiencies in the capital market, which was not able to automatically adjust the demand for capital to the excessively large supply of savings.

3rd The increase in demand for more free time

Independently of the question of the validity of Say's theorem, however, it is also necessary to examine whether the presence of saturation in consumer demand must necessarily also trigger unemployment. It would be very conceivable that a restriction of consumer demand to vital products does not at all have to lead to a supply overhang on the labour market and thus to unemployment.

In order to better understand this thesis, let us ask ourselves how people would proceed if we were still living in a medieval society in which production was not yet based on the division of labour, i.e. each individual peasant family would essentially only produce for its own needs. Let us now assume that a farmer had learned and applied certain production techniques that would allow him to obtain the goods necessary for his subsistence even if he limited his work to half a day.

We would assume in this case that this farmer would actually only work half a day at a time, i.e. that he would devote the rest of the time to his leisure and that he would therefore not slave away all day and produce more goods than he needs.

Why should such behaviour not be principally possible in an economy based on the division of labour? If, due to technical progress, our society is in a position to produce the quantity of goods needed for life with only half a day's work, why should the workers, who, according to the assumption, no longer demand goods, not strive on their own initiative to engage in gainful employment for only half a day? In this case, the demand for labour on the part of enterprises would indeed decrease, but this decrease would not lead to unemployment, since the supply of labour would decrease to the same extent. In other words: In this case, despite saturation, no major unemployment would be triggered. Here, too, if unemployment were to occur on a larger scale despite these correlations, we would have to attribute this condition to deficiencies in the market, so that in this case it would not be the decline in demand that would have caused unemployment, but some errors in the incentive system of the market economy.

4th The saturation thesis in a narrower sense

In the further course of this chapter we will now deal with the individual stagnation theories in somewhat more detail. Let us start with the underconsumption theory developed in the times of the early classical era.

It is assumed that the demand for labour depends ultimately on the demand for consumer goods. The demand for capital goods is thus regarded here as induced ultimately by the demand for consumer goods.

B = f(C)

with B: labour demand, C: consumption demand

Thus, if the demand for labour is not sufficient to guarantee full employment, then this can either be due to the fact that the demand for consumer goods has reached saturation (saturation thesis), or else that consumer demand would be sufficient to provide enough jobs if technology remained the same, but that fewer and fewer labourers are needed to produce a unit of consumer goods due to technical progress (robotisation thesis).

Let us initially turn to the saturation hypothesis: According to this hypothesis, needs were limited; average real income had risen so strongly in recent decades that a further increase in demand for consumer goods could not be expected on a large scale. Above all, it is no longer to be expected that the average demand for consumer goods would increase so strongly that unemployment could be reduced to a large extent.

This view is based on the conviction that on the one hand, in the course of industrialisation, the production of consumer goods could be increased enormously compared to pre-industrial production, but that on the other hand, the needs of the people were largely predetermined and constant.

Although the first Gossen's law, named after Herrmann Heinrich Gossen, was not developed until 1854, the saturation thesis is obviously based on a similar correlation. As is well known, Gossen's first law states that the more of a good is consumed, the more the utility increase of a unit of consumption diminishes. The first glass of water may save a person dying of thirst from death and thus bring an infinitely high utility, a second or third glass of water may still have been associated with a certain utility, but the increase in utility of each further glass of water decreases and very soon reaches zero.

Similarly, the saturation thesis assumes that with a permanent increase in per capita income, a condition is reached very soon from which on a saturation of all basic needs has occurred, from which an increase in consumption can no longer bring any further utility.

We had already mentioned that Joseph Alois Schumpeter accused the advocates of such a saturation thesis of being unimaginative and of having been refuted time and again by history, every phase of stagnation has so far been followed by a renewed upswing after a few years and these upswings have been characterised by the fact that the real quantity of goods has increased from business cycle to business cycle.

The flaw in the saturation theories is twofold. On the one hand, these theories fail to recognise the possibility of enormously increasing the utility of consumer goods through quality improvements. It is true that one will not be able to fill one's stomach more than full, but an expansion of production by no means lies only in the fact that more quantity units of a good are produced and consumed. Rather, economic growth is characterised above all by the fact that the quality of the individual goods has been improved steadily. In the past, for example, a pencil (writing tool) and a few sheets of paper were enough to write down some thoughts. Today's authors can use highly complicated computers and sophisticated text and image programmes to write down their thoughts. Moreover, there are almost no limits to improving the quality of food.

At the same time, technical progress has contributed to people being able to afford things today that people could only dream of in the past. Just think of the possibility of flying. Or if we ask about domestic conveniences such as bathrooms, shower facilities, refrigerators, which are now taken for granted by more than 90% of the population, these are luxuries that the Sun King Louis XIV could only dream of and would envy the commoners living today.

This means that we cannot assume a demand structure that is given a priori for all times; in reality, the average demand of people has increased almost as fast as the production of the individual goods.

5th The robotisation thesis

Another reason for the stagnation in labour demand lies in the hypothesis of robotisation: Within the framework of this thesis, the opinion is held that technical progress would necessarily lead to more and more labour being replaced by capital, namely in that more and more work processes are taken over by robots. This mechanisation process would lead to the destruction of more and more jobs and that the remaining jobs - even if consumer demand was actually high - would no longer be sufficient to guarantee full employment.

This thesis is argued above all with regard to the physical labour force. The invention of steam power at the beginning of industrialisation and the electric motor initially made it possible to support physical labour. The further fact that due to the invention of the computer, the mental abilities of machines could also be simulated, then made it possible to develop robots that could take over the physical work processes on the one hand and on the other hand monitor the individual work steps independently. Nevertheless, it still requires the mental effort of humans to make new inventions, to determine which goals are to be pursued with the help of these production machines and to check to what extent technical processes can actually fulfil their task.

It can hardly be denied that such a development has occurred in the last century. In a first phase of industrialisation, the physical labour of animals was replaced by work-performing machines. Whereas in antiquity and the Middle Ages, for example, people moved from one place to another on horseback or in horse-drawn carriages, this task of locomotion was taken over by the car or also by rail vehicles such as trams and trains. Later on, the use of aeroplanes was also introduced.

In addition, other machines took over partial tasks, such as excavating soil or moving heavy objects of all kinds, which required a particularly large physical effort, however, these machines were initially still used and controlled by humans in a purposeful manner. It was not until the invention of the computer that a development began in which ever larger sections of an enterprise independently take over the entire work process.

In fact, a large part of the work in industry today, which was still done by workers in the early stages of the industrial age, is nowadays done more or less by machines working independently. From an economic point of view, the production factor labour has been increasingly replaced by the use of capital.

However, it would be wrong to assume that this development was unavoidably given and could not be stopped by conscious human intervention. The fact that this development could be observed in recent decades is closely related to the kind of technical progress. However, technical progress does not fall out of the sky like manna from heaven. The fact that labour-saving technical progress has occurred to a very large extent in recent decades is closely related to the incentives of our economic system.

In general, we distinguish between labour-saving and capital-saving progress. According to a definition by J. R. Hicks, we speak of labour-saving progress whenever, with a constant wage-interest ratio, the labour intensity (the number of labour units per unit of capital employed) decreases. In a similar way, we speak of capital-saving progress when, with a constant wage-interest ratio, labour intensity increases. If, despite technical progress, labour intensity was to remain constant with a constant wage-interest ratio, and if therefore productivity increases were reflected equally in savings of labour and capital, this would be known as neutral technical progress.

The type of technical progress that entrepreneurs decide on depends largely on the wage-interest ratio. The more the wage rate rises in relation to the interest rate, the more entrepreneurs strive to replace labour with capital and thus to initiate a robotisation of industrial production. If capital becomes cheaper in comparison to labour, an enterprise can reduce its unit costs by replacing labour with capital and thus gain a competitive advantage.

As long as the wage-interest ratio reflects the scarcity relations of labour to capital, a substitution of labour and capital would also be desirable from both an economic and a social point of view. Wages would rise in comparison to the interest rate precisely when labour became scarce and when, because of this scarcity, certain goods and with them certain needs of people could not be satisfied. In this case, production and thus general economic welfare can be increased if labour-saving techniques are introduced; more products can now be produced per unit of labour employed. But at the same time, full employment is guaranteed; since the labour-saving technical progress was only chosen because there is a shortage of labour force and because without these labour-saving methods merely a lower level of production could be achieved.

In a functioning market economy, the wage rate rises in relation to the interest rate only when labour is scarce. If, however, the wage rate rises in relation to the interest rate even though unemployment prevails, labour-saving progress still leads to an increase in productivity, more products can still be produced with one unit of labour, but in this case this additional production could also have been achieved by employing the now unemployed workers. In this case, labour-saving technical progress is not a social progress, since the employment of all workers who are able and willing to work should always have priority over an increase in the quantity of production.

Now we have already pointed out elsewhere in this lecture that the Keynesian employment policy is supported by a policy of cheap money and that here the interest rate of the central bank is deliberately pushed below the interest rate which would have made equilibrium possible on the capital market. In this way, a wage-interest ratio is targeted that is below the wage-interest ratio that would have guaranteed full employment. In other words, employment policy contributes to the fact that unemployment actually increases in the long term: Because the interest rate is too low, more labour-saving technical progress is carried out, with the result that additional workers are laid off.

This effect is further strengthened if, in addition to the policy of cheap money, the trade unions enforce an expansive wage policy in which the increase in wage rates exceeds the increase in labour productivity. In this case, the wage-interest ratio rises on the one hand because interest rates fall, and on the other because wage rates rise.

Such an expansionary wage policy was justified by the fact that in this way demand for consumer goods and thus indirectly also demand for labour could be triggered. However, we have already had to point out elsewhere that within the framework of Keynes' theory only an increase in autonomous consumption demand has a production-increasing effect and thus also an employment-increasing effect, while an increase in consumption demand due to a rise in wage income only represents an induced increase in demand. Only when the demand for consumer goods rises more strongly than the income does then the consumption function shifts upwards and therefore a goods equilibrium with greater employment is headed for. An increase in consumption demand due to an increase in wage income merely represents a movement along a constant consumption function and does not lead to a new, higher equilibrium on the goods markets. However, if there is no increased production in the long run, a sustained increase in employment cannot be expected.

6th The stagnation thesis of Alvin Hansen

We have already pointed out that Keynesian theory primarily assumed that unemployment was a cyclical and thus temporary problem; periods of depression would eventually be replaced by periods of recovery. Within the Keynesian movement, however, there were also attempts to develop a theory of secular stagnation. Alvin Hansen, the main representative of this direction, was convinced that industrial societies were facing the danger of long-term stagnation with persistent unemployment. With this, Alvin Hansen took up considerations that were already widespread in the classical doctrine in connection with the thesis of underconsumption.

In contrast to the classical theory (Malthus), which attributed the stagnation tendencies to excessive population growth, Alvin Hansen assumed that modern industrial societies were characterised by population stagnation. On the one hand, the development of modern social security and pension systems had eliminated the compulsion that existed in pre-industrial societies to have as many children as possible to provide for old age. On the other hand, the development of contraceptives has also made it possible to bear fewer children without abstinence.

This decline in the birth rate has now led to a drastic decline in the volume of investment. As long as the birth rate was high, the demand for new housing and jobs was high, and in both cases high investment was necessary to ensure this demand. This need for investment ceased to exist when the population stagnated and therefore neither new housing nor jobs had to be created. The demand for investment had thus fallen, while at the same time the savings rate and the volume of savings had risen due to productivity growth. The result was a permanent oversupply on the capital markets, with the consequences for the labour market described in Keynesian theory. The state could only counteract this tendency through a permanent deficit in the national budget.

This theory must be countered by the fact that population stagnation in industrialised nations is not inevitable. As the example of the USA shows, it is precisely in economies with a very high level of prosperity that an increase in the population growth rate can be expected. On the other hand, the example of France shows that a correction in population development can also be initiated through population policy measures. It is also wrong to think that only the creation of additional housing and additional jobs will trigger sufficient investment needs. High and sufficient investment needs can also come about by improving the quality of housing and jobs. Especially in connection with environmental problems, an enormous need for investment is likely to be triggered in the future.

If we do not limit ourselves to the development within the older industrial societies, but ask ourselves about the population development of the entire world, we are nowadays not so much faced with the problem of population stagnation, but with an enormous growth of the population, which is so strong that there is a danger of having reached the limits of growth. The stock of natural resources is no longer sufficient to support this population growth for a longer period of time, less and less scarce resources are being passed on to future generations, and at the same time, the past energy supply via fossil fuels (coal, oil and gas) has led to dangerous, life-threatening climate change.

This rapid population growth in the economically developing and emerging countries is similar to the population development that the European industrial nations also experienced in their initial phase. Just as in the European industrialised nations a population stagnation set in after a certain time, it could be assumed that today's emerging countries will also eventually reach a stage in which the population stagnates due to increased prosperity. However, it is to be feared that without dramatic changes in energy supply and the industrial mode of production, the 'world economy' will run into serious difficulties.