Demand-Side Economics

Home / Analysis / Demand-Side Economics

From now on, the Principles series is going to go a little deeper. The posts from now on will be sorted under the Analysis series. As we discussed a little in the previous episode of the Principles series, Demand-Side Economics is what we will discuss further in this episode today.

What the previous Principles episode made was the claim that at the macroeconomic end of the scale, the trend of the policies of national governments and international bodies has been to support the supply side of the equation . This is quite a claim to make I know, but it is quite simple to understand how it can be made. This is otherwise known as supply-side economics, and has been a vital ingredient in the neo-classical economic, academic framework for quite a long time. As this online resource explains:

“Higher income levels and living standards cannot be achieved without expansion in output. Virtually all economists accept this proposition and therefore are ‘supply siders'”.

By clicking on the “supply-side economics” link above, you can see furthermore what this actually means. The supply-side orthodoxy is essentially focussed on the idea that a saturation of supply (measured through the output and quantity of businesses and their products) is synonymous with increased competition and investment. The orthodoxy is that this plurality will maintain a level of employment and lower prices, allowing for a comfortable cost-of-living and thriving private sector. As we look at the evidence however, we can see that this is largely false, and that a similar focus on the stimulation of the demand-side of the equation is as equally as important as its opposite. At a global level, this has hardly ever been so clear. As this article by the Financial Times asks:

“So why isn’t growth accelerating? The simple answer is that falling oil prices, low interest rates and monetary accommodation are not random windfalls, but are instead responses to an excess of global supply relative to global aggregate demand”.

At a national level – as Robert Reich, the University Public Policy professor from Berkeley, and secretary of labour under Bill Clinton says: businesses can only make profits when they have potential customers. In other words: an equal level of demand to match supply in the economy. As was the logic behind Henry Ford’s decision to pay his employees a decent living wage including social benefits.

The good thing is, we can actually measure this potential. It’s called aggregate demand:

uk_econ_aggregate_demand

Here we have this measurement, of the potential customers in the UK economy. A chart of the different components in the UK that comprise its aggregate demand prior to 2013. Aggregate demand is actually measured in nominal terms, by-passing inflationary effects by taking prices from a fixed period of time. In this case, the UK prices in 2003.

This chart shows not only the purchasing power of consumers, but the amount of spending on all goods and services in the economy. So basically, aside from the fact that the UK is still spending more on imports than exports, what we see here is – when taking into account the drop around the time of the credit crunch (financial crisis) of 2008, consumer spending (the potential customers of businesses) has grown by about 0.31 thousand billion pounds. An average of 0.019 thousand billion pounds per year since 1997.

ADAS

This does show a rising trend in the overall demand of consumers in the United Kingdom. Although, as we can see from this graph above demonstrating the basic law of supply and demand – a satisfactory price level in economies rely on an equilibrium between supply and demand. Also, if possible – a mutual growth between supply and demand. By looking at the United Kingdom’s aggregate demand increase of 0.31 thousand billion pounds in the space of 16 years, alongside an extremely modest figure of no more than 0.3 thousand billion pounds in capital investment during this same period, is it exactly an equilibrium what we see here?

UK-v-g7-real-wages

When we actually look at the average real wage index for developed G20 countries between 2007-13, what we do see is a trend which contradicts any possibility of an increase in real-terms UK consumer spending.

united-kingdom-consumer-price-index-cpi

The UK consumer price index, which measures the inflation of average consumer basics shows how this trend might have occurred; the cost of these consumer basics have undergone an increased rate of inflation since 1990. In relation to the UK’s wage packets, this undoubtedly has contributed to a fall in their real terms pay.

uk-real-wages-06-14-600x401

And above is the graph which confirms it. In a period of 7 years, from 2007 to 2014 – as consumer spending was still increasing post-2009, we have a totally contradictory picture – of basic consumer goods experiencing a high rate of inflation, and real wages (wages adjusted for inflation) on a continuous negative trend throughout the entirety of this period.

What we see in the graph of UK aggregate demand and it’s consumer spending actually negates the factor of inflation due to only using 2003 prices of consumer goods. However, placed in comparison with real wages and especially the real wages of other countries, we can see that the rise in consumer spending is somewhat suspicious.

If real wages have stagnated consistently for such a long period in the UK, it is not much of a logical leap to consider that this growth in consumer spending has been carried not by income or wages, but by wealth.

income growth at the top

Despite the fall post-2008 shown here, the consistency of the rise in wealth for the top 0.01 and 1% correlates with the consistency of the rise in aggregate demand in consumer spending. Essentially, what we can take from this is that the UK economy is one whereby its consumer aggregate-demand is reliant upon a worsening situation of wealth inequality; the disposable income of its higher earners. Coupled with a situation where the real incomes of average earners stagnate, this is all indicative of an over-saturation in the implementation of supply-side policies.

To answer the question of whether aggregate supply and demand is at a level of equilibrium, in this case the absolute most leeway we could give is the answer of yes – on very fragile terms.

Now, it is correct that this situation that we have found in the UK economy is exacerbated due to tax havens around the globe, the super rich and powerful corporations and bodies which exploit global capitalism and the hyper mobility of capital. But, it is also the case that this is furthermore exacerbated when we consider what we call the concept of marginal propensity to consume.

This shows us that for those with lower incomes, they’re more likely to consume with any extra disposable income that they may receive rather than save, thus stimulating their local economies. Those on higher incomes are less likely to consume, and more likely to save: their marginal propensity to save is higher. They’re more likely to use their exclusive benefits of a global economy to accumulate more capital. Not reinvest or consume. See below:

mpc_0

If we believe Keynes, the marginal propensity to consume is less than one. People generally don’t consume more than what they receive as disposable income. Although, as we can see in the UK, the situation has gotten to the point where this is not true. As a matter of basic subsistence for individuals, due to the levels of real wages – it is necessary for them to spend more than whatever they receive as income in cases in order to survive. Due to their (mostly unfortunate) situations they therefore rely on cheap credit, creating a personal debt spiral for themselves.

householdebt

We can see this in the graphic above with ‘households’ gross disposable income’ rising steadily, while ‘total credit outstanding’ picks itself up at more of a pace.

If the current levels of aggregate demand at the bottom of the pay scale, or even for average earners are falsely propped up by cheap credit with incredibly high and unsustainable interest rates, this unfortunately means great instability for the whole UK economy.

As we can see from all of this, the levels of aggregate demand are comparably fragile. When we consider marginal propensity to consume, we can see which proportion of this aggregate demand in the UK economy is actually unsustainable, and a wasted potential of economic activity. Through this, you can also have a clear picture of how demand in the UK economy is neglected overall.

And that’s it for this episode.

Leave a comment if you have anything to add or dispute.

Facebooktwittergoogle_pluspinterestlinkedintumblrFacebooktwittergoogle_pluspinterestlinkedintumblr

Leave a Reply

Your email address will not be published. Required fields are marked *