[Marxism] Capacity utilisation and the fetters of the productive forces in the world economy

["Jurriaan Bendien" <andromeda246@xxxxxxxxx>]

(thought I'd just post this brief note).



Recently UMC, the world's second-largest made-to-order chipmaker, said "the
capacity utilization rate of the corporation may drop to approximately 70
percent in the fourth quarter, compared with 94 percent in the previous
quarter". This made me interested to find out some more about capacity
utilization rates in the modern world.



You might think this is a joke, but many economists don't think so. The
economist James Crotty mentions some business comments on the issue in the
peak years of the 1990s bubble: Business Week noted that "supply outpaces
demand everywhere, sending prices lower, eroding corporate profits and
increasing layoffs." (Business Week, January 25, 1999, p. 118.) Former
General Electrics chairman Jack Welch claimed that "there is excess capacity
in almost every industry" (New York Times, November 16, 1997, p. 3.) The
Wall Street Journal observed that "from cashmere to blue jeans, silver
jewelry to aluminum cans, the world is in oversupply." (Wall Street Journal,
November 30, 1998, p. A17.) The Economist worried about "a malign deflation
caused by excess capacity and weak demand," speculating that the gap between
sales and capacity is "at its widest since the 1930s." (Economist, February
20, 1999, p. 15).



But the problem is chronic, and should be placed in historical perspective.
The United Nations estimated that world GDP grew at an annual rate of 5.4
percent in the 1960s, 4.1 percent in the 1970s, 3 percent in the 1980s, and
2.3 percent in the 1990s (United Nations, World Economic Survey (New York:
United Nations, various issues). At the same time, the average excess
capacity has also grown. The average capacity utilization rate in the US
economy since 1967 was 81.6% according to the Federal Reserve measure. The
figure for Europe is not much different, for Japan only slightly higher.



One of the most used definitions of the "capacity utilization rate" is the
ratio of actual output to the potential output. But potential output can be
defined in at least two different ways.



One is the "engineering" or "technical" definition, according to which
potential output represents the maximum amount of output that can be
produced in the short-run with the existent stock of capital. Thus, a
standard definition of capacity utilization is the (weighted) average of the
ratio between the actual output of firms to the maximum that could be
produced per unit of time, with existing plant and equipment (see I.
Johanson, Production functions and the concept of capacity", Collection
Economie et Mathematique et Econometrie, 2, 1968, pp. 46-72). Obviously,
"output" could be measured in physical units or in market values, but
normally it is measured in market values.



However, as output increases and well before the absolute physical limit of
production is reached, most firms might well experience an increase in the
average cost of production, even if there is no change in the level of plant
& equipment used). For example, higher average costs can arise, because of
the need to operate extra shifts, undertake additional plant maintenance,
and so on.



An alternative approach, sometimes called "economic" utilization rate, is
therefore to measure the ratio of actual output to the level of output,
beyond which the average cost of production begins to rise. In this case,
surveyed firms are asked by how much it would be practicable for them to
raise production from existing plant and equipment, without raising unit
costs (see E. Berndt & J. Morrison, "Capacity utilization measures:
Underlying Economic Theory and an Alternative Approach", American Economic
Review, 71, 1981, pp. 48-52). Typically, this measure will yield a rate
around 10 percentage points higher than the "engineering" measure, but time
series show the same movement over time. As a derivative indicator, the
"output gap" percentage can measured as actual output less potential output
divided by potential output x 100.



In the survey of plant capacity used by the US Federal Reserve Board for the
FRB capacity utilization index, firms are asked about "the maximum level of
production that this establishment could reasonably expect to attain under
normal and realistic operating conditions, fully utilizing the machinery and
equipment in place." By contrast, the Institute of Supply Management (ISM)
index asks respondents to measure their current output relative to "normal
capacity", and this yields a utilisation rate which is between 4 and 10
percentage points higher than the FRB measure. Again, the time series show
more or less the same historical movement.



So how are things with utilization levels of installed productive capacity
in industries these days? Here are some FRB-type estimates in round figures
for major economies:



United States 77%

Japan 83% (manufacturing) 86% (non-manufacturing)

Europe 82%

Brazil 60-80%

India 60-80%

China around 50-60% (higher in the industrial cities)



So as you can see, there really is considerable "slack" in the world
economy. Normally the utilization rates are higher in the equipment goods
and raw materials sector (Marx's "Department I") than in the consumer goods
sector ("Department II"). Thus, typically in Department I the modern rate is
80-85%, and in Department II it is around 75%. We should however really add
Department III (luxury production) and Department IV (weapons production)
and in these industries, capacity utilization is higher than the average
(the global weapons industry is a US$1 trillion a year industry; We are
probably on safe ground though, if we assert that about 1/5 of the world's
installed industrial productive capacity is not being used.



How can excess capacity be explained? If, like Al Greenspan, you believe in
Say's Law, then supply begets its own demand, and chronic excess capacity
cannot exist, anymore than chronic high debt levels can exist. But they do
exist, so why is that? Basically, because productive capacity has grown
faster than monetarily effective demand.



Economist James Crotty explains, "Global neoliberalism increased the
intensity of competition by slowing demand growth, which created widespread
excess capacity, and by eliminating cross-border barriers to competition. As
a result, we have witnessed an outbreak of what I call "coercive
competition," leading to cutthroat pricing, the destruction of secure
oligopoly profit margins, and rising financial fragility in core markets"
(James Crotty, "Why there is chronic excess capacity - The Market Failures
Issue" Challenge,  Nov-Dec, 2002).



Specifically, Crotty notes real wages were restrained by high average
unemployment, the decline of unions, weaker government support for
collective bargaining, and a worldwide decline in real productivity growth.
High real-interest rates were imposed after 1980 by independent,
conservative, and inflation-obsessed central banks.  The growth of
government spending declined because of lower profits, higher real-interest
rates, increased uncertainty sluggish aggregate demand growth, and
conservative attacks against government spending. Fiscal policy became
increasingly restrictive. Liberalization programs have severely weakened
state-guided development models across the third world, leading to foreign
take-overs of local plants but not to significant expansion of total output.
The spread of IMF- and World Bank-mandated austerity and restructuring
programs across the developing world has also badly hurt global demand
growth.



According to one school of thought, if excess productive capacity is
scrapped through the closure of less efficient companies and plants, then
the profitability of the survivors must improve. But in practice, shutting
down less profitable companies tends to make things worse, not better, for
the survivors. As the least efficient plants are shut down, unemployment
rises faster than capacity falls. But the effect is not just to reduce
installed capacity; it also cuts domestic demand, which declines as
employment is reduced. Unless the savings rate falls (and it usually rises
as job losses mount), demand falls faster than capacity. This means that
capacity utilisation does not rise in proportion to capacity scrapped, but
actually falls. As capacity utilisation falls, competition becomes even more
intense, and profits fall. For individual companies, cost cutting helps but,
if it becomes generalized, profits fall. Thus, profits remain depressed
despite the ferocity with which costs are being cut.



What is the result of all that? Essentially, a growing mass of surplus
capital which is no longer invested in production, because it is not
profitable, or too risky. As Marx showed in his analysis of economic
reproduction in Capital Vol. 2, there are essentially three main forms of
capital: production capital, commodity capital and money capital. So a
situation of excess capital means that an increasing portion of the stock of
total capital takes the form of trade in existing financial and physical
assets, rather than being invested in an expansion of real production. For
the rest, it is expended on luxury consumption. This does create additional
employment in financial services, commercial trade, real estate, leisure,
insurance etc. but basically it concerns mainly people who already own
substantial assets and collateral, which enables them to borrow, trade and
consume. Hence the relative stagnation of the real economy and growing
income inequality.



There have been plenty debates about "long waves of capitalist development",
but if the Marxian argument - such as presented by Ernest Mandel - is read
carefully, it's clear that long waves are not at all "cyclical", and that no
new long wave of rapid economic growth is likely to be in prospect. The
reason is that for this to occur, rising profitability must coincide with
expanding real demand. Essentially, the apparent "boom" in the 1990s was
achieved through a rise in the rate of surplus-value (gross profits/real
wages ratio, if you like), deficit financing (credit and debt creation) and
property speculation. Demand levels have been sustained to an important
extent by credit creation.



The only way to reach prolonged higher economic growth is, if somehow
aggregate demand was levered up in a sustainable way, and if new
technological innovations would radically reduce production costs. As
regards the former, however, the experience of neoliberal attempts at market
integration suggest that, whereas more people can be integrated in markets,
especially in services, their real wages tend to stagnate or fall while
debts rise. As regards the latter, the technological trend is towards
automation, which reduces employment and therefore demand. So in the longer
term, any prospect of a return to rapid economic growth depends on a radical
change in the whole social framework of capitalism. In the meantime, the
most likely prospect is continued relative stagnation, i.e. slow or zero
real growth because of surplus capital, and the restrictions on demand.



Marx wrote in "The German Ideology" that "In the development of productive
forces there comes a stage when
productive forces and means of intercourse are brought into being, which,
under the existing relationships, only cause mischief, and are no longer
forces of production but forces of destruction (machinery and money); and
connected with this a class is called forth, which has to bear all the
burdens of society without enjoying its advantages, which, ousted from
society, is forced into the most decided antagonism to all other classes; a
class which forms the majority of all members of society, and from which
emanates the consciousness of the necessity of a fundamental revolution, the
communist consciousness, which may, of course, arise among the other classes
too through the contemplation of the situation of this class."



It could be a prophetic comment.



Jurriaan







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