Worrying About Demand

According to economic theory, demand will equal supply at the "equilibrium" price level. In practice, lack of demand in the economy might now and then become a threat to employment, and even force nations to spiral down into depression. Lack of demand is currently a topical issue, both for economists and participants in the financial markets. Liberals like Krugman often mention how the current US administration's policies have failed to spur demand from middle class households. I came here trying to start a wider discussion of what factors - apart from the often discussed fiscal and monetary policies - we need to worry about in this context.

Today's offshoring, and fast technological change makes fundamental prices of labor more volatile. However, labor is (thankfully since the Civil War) traded only under heavy restrictions. This combined with low inflation and the traditional or psychological constraint on nominal wage changes to be at or above zero - some labor are becoming overpriced. Too high a price drives demand down - this would be my first factors threatening demand. And as Mark Fiore states in one of his cartoons - workers avoiding being overpriced by working harder and long hours puts pressure on relative demand by increasing supply.

The second set of demand threats I would propose is the productivity increase from technological change and employee's learning-by-doing. According to standard theory, anticipation an of productivity increase would make households save some work for the more efficient future, while tending to consume some of the future gains in advance. But if a large part of the economy's capital is represented by worker's skill, they would probably like to work more when new technologies arrive, in order to add to that capital. Workers would tend to work more rather than less, again increasing supply rather than demand.

Another factor coupled to these is the non-standard but not unheard of 'keeping-up-with-the-joneses-utility'. If household's perceived standard of living is linked to how much they earn relative to what their neighbors earn rather to actual number on the paycheck, this could (if you have IE 6.0 shrink this window somewhat before clicking the link) diminish the tendency to consume future productivity gains in advance. As technological change means increased wage variablility, it could instead make households save for the future, to prepare for the increased risk of earning significantly less than their neighbors.

Finally, again non-standard, but not entirely exotic: 'habit-persistence'. The households that benefit from increased wage variability (Chinese, Indian middle class?) might still keep some of their own habits, failing to demand all the gains from their new higher paying jobs.

Admittedly, this discussion is biased towards looking at the threats to demand. But insofar these links between faltering demand and low-inflation, good productivity gains, offshoring and 'learning-by-doing' have some validity, there is room for worrying. We actually have quite a lot of those factors in place today.