Thorstein Veblen
"The Overproduction Fallacy"

The Quarterly Journal of Economics, Vol. VI. (Jul., 1892), pp. 484-492.
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I.
In the April number of this Journal Mr. Uriel H. Crocker publishes what 
purports to be a rehabilitation of the "overproduction" theory of 
industrial depression.(1*) The paper deals specifically with Mill's 
discussion of the question, and it is particularly Mill's position that is 
claimed to have been refuted. It may, therefore, not seem ungracious to 
call to mind that, so long as we employ "demand" and "supply" in the 
meaning attached to those terms by Mill and commonly accepted by those who 
are of his way of thinking, the proposition that aggregate demand equals 
aggregate supply is a truism. General overproduction, as defined by Mill - 
"a supply of commodities in the aggregate, surpassing the demand" - is a 
contradiction in terms. Aggregate supply is aggregate demand, neither more 
nor less.
The above-quoted definition of overproduction occurs in the pages cited 
from Mill by Mr. Crocker, and can therefore hardly have escaped his notice. 
But, as it seems not to have furnished any obstacle to the development of 
Mr. Crocker's argument, the simple calling attention to its significance 
will hardly be accepted as subverting the position taken by him. Mr. 
Crocker's position is not a simple, crude denial of Mill's proposition in 
this general form; but I believe it can be shown that the line of argument 
by which that position is supported is no less futile than the naive 
overproduction theories that have been laid away by past economic 
discussion.
To Mr. Crocker's mind, the question as to a possible general overproduction 
takes form as follows:
Is it possible that there should exist at any time an overproduction of one 
or more products, unless there is at the same time a corresponding 
underproduction of some other product or products? In other words, is it 
possible that one product should be selling for less than the ordinary 
profit over the cost of its reproduction, unless some other product is at 
the same time selling at more than the ordinary profit over the cost of its 
reproduction? (p. 356.)
His answer to this question is the following proposition:
If at any time there is a production of a commodity not based upon and 
strictly proportioned to the adequate demand for it, but, with the 
knowledge of the producer, in excess of that demand, then there may at such 
time be an overproduction of that commodity and no corresponding 
underproduction of any other commodity. In other words, there may be in 
such case a general overproduction. (p. 356.)
The final conclusion is stated in this second proposition:
A production of a commodity not based upon and strictly proportioned to the 
adequate demand for the product, but, with the knowledge of the producer, 
in excess of that demand, may arise, and has, in some cases, actually 
arisen, when machinery for the production of the commodity has been created 
with a capacity of production in excess of the adequate demand for the 
product. (p. 358.)
The use of the term "adequate demand" is to be noted. "Adequate demand" is 
"the demand for a commodity at such a value as will afford the ordinary 
profit over the necessary cost of its reproduction." (p. 355.)
The concept of an "adequate demand" rests on the concept of an "ordinary 
profit." Now, we can intelligibly speak of adequate demand and ordinary 
profit without questioning either of those terms, so long as the discussion 
is concerned with the production of a particular commodity, or with a part, 
only, of the aggregate of industry. But a closer scrutiny will show that 
both terms break down when we come to deal with production in the 
aggregate.
The "ordinary profit," which an adequate demand must cover, is not a 
satisfactorily definite concept. It may be taken to mean the rate of profit 
commonly obtainable at the point of time with which the discussion deals, 
or it may mean the rate of profit that ought to be commonly obtainable at 
the time, or it may mean the rate of profit commonly obtainable during a 
more or less indefinite period preceding the time in question. In its 
colloquial use it has both the latter meanings, mingled in varying 
proportions. Which of these, or any other possible meaning, Mr. Crocker 
attaches to the term he does not say. The line of argument pursued by him 
requires the first of these definitions, or some definition which is like 
the first above given in being based on the rate of profit actually 
obtained at the time in question, and, therefore, to a good extent, if not 
entirely, of the nature of an average of the profits actually obtained.
The ordinary rate of profit, in this sense, notoriously varies from time to 
time. The variations to which it is subject are due to particular 
variations in particular occupations. Being of the nature of an average, it 
varies with the fluctuations of the items that go to make up the average. 
If, in the manner supposed in Mr. Crocker's first proposition (P. 356), a 
given commodity comes to be produced at less than the ordinary profit 
previously obtained, the ordinary profit obtainable thereby suffers a 
reduction, and, compared with the new ordinary profit therewith 
established, other commodities are now produced at more than ordinary 
profit; that is to say, overproduction of one commodity involves, other 
circumstances remaining unchanged, an underproduction of all other 
commodities, in the sense attached to "overproduction" by Mr. Crocker. The 
case supposed by Mr. Crocker resolves itself into a variation in the 
ordinary rate of profit.
From the general point of view, it is clear that any variation in the rate 
of profit in any one or more branches of industry, or in the production of 
any particular commodity, produces a variation, in the same direction, in 
the ordinary profit obtainable at the time in question, and a consequent 
divergence of the rate of profit in other occupations, in the opposite 
direction, from the new "ordinary profit." If the rate of profit in 
occupation B were to fall, without any change in the absolute rate of 
profit in occupation A, the ordinary rate of profit obtainable in the 
aggregate of occupations would fall; and consequently the rate of profit in 
occupation A would thereby rise, relatively to the altered general rate. 
The demand which previously was an "adequate demand," and no more, for the 
product of occupation A, would now have become an over-demand, not, 
conceivably, because of any change affecting the demand for that product 
directly, but simply in consequence of a change in the "ordinary profit" 
with which the rate of profit in occupation A is to be compared.
That is to say, there would be an underproduction in occupation A in 
consequence of there being an overproduction in occupation B. It is 
accordingly necessary to say that any over-supply of one commodity implies, 
or rather involves, an under-supply, in the strict economic sense, of some 
or all other commodities. The first of Mr. Crocker's propositions therefore 
breaks down.
It is to be remarked that the typical case cited by Mr. Crocker (p. 358) of 
a production "not based upon ... the adequate demand" also breaks down when 
it comes to the concrete application in the second of the two propositions. 
And the like would probably be true of any conceivable case. It is a case 
of an excess of production of a particular commodity, due to the creation 
of more fixed capital of a given kind than the adequate demand for the 
product would warrant, and resolves itself into a case of misdirected or 
"ill-sorted" production, such as Mill has specially provided for in his 
discussion. It is a case of relative overproduction of a special kind of 
fixed capital, and a consequent depreciation of that fixed capital, either 
permanent or temporary. The reason for the continued production of goods to 
be sold at what the producer conceives to be less than a fair return is, 
professedly, the fact that an undue proportion of the aggregate capital has 
been fixed for the production of the particular commodity in question.
II.
While the doctrine of a general over-supply of goods -in the sense in which 
it has been criticised in economic theory-is palpably absurd, it must be 
admitted that the cry of "overproduction" that goes up at every season of 
industrial depression has a very cogent though perhaps not a very 
articulate meaning to the men who raise the cry. What is the nature of the 
fact that is symbolised by the colloquial use of " overproduction," and how 
it is related to "depression" and "liquidation," has never been 
satisfactorily made out. But no doubt it stands for an economic fact that 
merits the attention of any one who is curious to understand the phenomena 
of hard times and commercial crises.
The passages which Mr. Crocker quotes from D. A. Wells's Recent Economic 
Changes - and, more distinctly, certain other passages of that book - 
indicate the difficulty rather than solve it. It should be said, by the 
way, that Mr. Wells claims no originality with respect to the theory, or 
rather statement, which he puts forth, though he gives it a conciseness 
which it hardly had before.
General "overproduction," in Mr. Wells's use, means a general production in 
excess of the "demand at remunerative prices." And a remunerative price may 
be defined, for the present purpose, as a price that will afford the 
customary profit on the capital invested. If general prices become 
"unremunerative," the meaning of that fact, as expressed in terms of this 
definition, is that the general run of profits has fallen below what is 
accepted as the customary rate of profits, or below the "ordinary profit," 
in the sense of what the business community accepts as the proper or 
adequate rate of profits for the time being.
"Overproduction," in the colloquial use of the word, as appealed to in 
explanation of depression in trade, is used to describe a situation where 
goods have been produced in excess of the demand at such prices as will 
afford the customary profit on the capital employed in their production. 
The average profit obtainable at the time on the capital invested falls 
short of the standard accepted as the proper, customary profit. This need 
not mean that the rate of discount at the time falls short of what is 
conceived to be the proper, customary rate. The trouble lies not primarily 
with the rate of profit on new investments, as indicated by the rate of 
interest on money seeking investment, but with the rate of profit on 
property already invested and capitalised in the past. The point of 
complaint is as to the earning capacity of investments already made. There 
may be much that is unsatisfactory with respect to the making of new 
investments; but that class of difficulties is evidently an effect, never a 
cause, of the trouble that exists with respect to the earning capacity of 
capital already invested and "capitalised" in the past.
The average rate of profit from past investments, indicated by the ratio of 
their earning capacity to their accepted capitalisation, falls short of the 
accepted customary profit, indicated by the customary rate of interest on 
money seeking investment. The precise difficulty is that a divergence has 
taken place between the accepted nominal value of property, based on its 
past capitalisation, and its actual present value, indicated by its present 
earning capacity or the present cost of replacing it. The actual present 
value of the property, as capitalised on the basis of its present earning 
capacity or on the cost of replacing it, falls short of its nominal, 
accepted value; and, as profits continue to be computed on the basis of 
this accepted nominal value, the rate of profit actually obtainable falls 
short of what is accepted as the customary and proper rate. The profit, 
computed on this basis, may even entirely disappear.
The "remunerative price," then, on which Mr. Wells bases his conception of 
"overproduction," turns out to be such a price as will afford the customary 
rate of profit to capital, as computed on the basis of its nominal value, 
or, in other words, on the basis of its accepted capitalisation. Now, 
whenever the course of industrial development compels a readjustment of the 
basis of capitalisation (as happens whenever the cost of production has 
been appreciably lowered), the customary basis on which the remunerative 
price has been computed becomes obsolete. The price, therefore, also 
becomes obsolete; and a reluctant acceptance of a new order of things 
follows, in which the capitalisation and nominal value of property are 
readjusted on a revised scale of prices, which, in the new epoch, fixes the 
"remunerative price" that now affords the customary rate of profit on the 
revised capitalisation.
The immediate economic fact for which "overproduction" stands is, 
therefore, a divergence between the nominal, accepted valuation and the 
actual present value of property engaged in production, in consequence of 
which the nominal earnings of capital (and in some cases the real earnings 
as measured in means of livelihood) are diminished. The characteristic fact 
in a case of general "overproduction" is that the basis on which 
"remunerative prices" and customary profit are computed has become 
obsolete. This divergence may be due to several different causes, but 
usually and mainly to two general ones - a speculative movement, and an 
increased efficiency of industry.(2*) The action of the former of these 
needs no discussion here. A speculative movement may have pushed prices up 
unwarrantably. A fall of general prices, due to improved processes of 
production, may have depressed the actual present money value of property 
engaged in production below its nominal value. For the present purpose the 
immediate result is in either case much the same: the nominal, accepted 
valuation of the capital, on which its returns are computed, exceeds its 
actual value as indicated by its present earning capacity. The property, 
perhaps the general aggregate property of the community, has come to be 
rated at a capitalised value above the cost at which it, or its equivalent 
for purposes of production, could now be replaced.
The hard times of the past decade are an example going to show how this 
result may be reached by a lowering of the cost of production; or, as some 
would perhaps prefer to express it, by an increase of the efficiency of 
industry.
If the analysis were carried a step further, it would appear that the 
divergence between the accepted valuation and the true present value of 
property, here ascribed to a lowering of the cost of production, is not due 
to the lowering of cost of production generally, simply as such, so much as 
to a lowering of the cost of production of some or all staple commodities 
as compared with the cost of production of the precious metals. The whole 
matter is very largely a matter of price - of "values" in the commercial 
sense.
Such a divergence between the accepted valuation and the actual value of 
capital may seem an inadequate basis for an economic fact of such magnitude 
as a period of industrial depression. And yet an industrial depression 
means, mainly, a readjustment of values. It is primarily, to a very great 
extent, a psychological fact. Secondarily, it is largely a matter of the 
shifting of ownership rather than a destruction of wealth or a serious 
reduction of the aggregate productiveness of industry as measured in goods.
The act of readjusting one's conception of one's own belongings to the 
scale of a reduced number of dollars, even though the dollar is worth 
enough more to make up for the nominal depreciation, is in itself a 
sufficiently painful one, and is submitted to only reluctantly and tardily. 
But this subjective element, this lesion of the feelings of the property 
owner, is by no means all that is involved in a decrease of the nominal 
earning capacity of capital. Whenever the nominal owner of the means of 
production is not also the real owner, as happens in the case of borrowed 
capital, he becomes answerable to the real owner - the lender - for any 
amount by which the actual present value of the property may fall short of 
the accepted valuation. A decline in the market value of property 
represented by the debt, therefore, means a real loss to the debtor, 
although, so far as it is due to increased efficiency of industry, it may 
be only a nominal loss to the man who has to do with his own capital only, 
and may be, and generally is, a source of distinct though unrecognised gain 
to the lender. The borrower assumes the risk of depreciation of the 
property represented by the debt.
In a case such as has been witnessed in this country during the past ten or 
twelve years, when there has been a pretty general decline in the cost of 
production of staple commodities - as compared with the standard of value - 
and a consequent decline in the nominal earning capacity of property 
engaged in production, of perhaps 30 percent, this factor is of the very 
gravest consequence. Especially is this true in the case of a community 
where so great a proportion of capital is represented by interest-bearing 
securities.
NOTES:
1) "The 'Over-Production' Fallacy" by Uriel H. Crocker, Vol. VI, April, 
1892.
2) The progressive accumulation of capital, by directly lowering the rate 
of profits, acts in the same direction as the two causes here mentioned; 
and some would perhaps rank it abreast with these two as an efficient 
agency in producing the situation for which an explanation is sought.
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