It is also known as the under-consumption theory of business cycles. It was propounded by socialistic-minded economists like Mahor Douglas and J. A. Hobson. The underlying cause of depression, according to this theory, is the inequality of incomes that prevails in a capitalistic society. The propertied classes have too much wealth- more than what they can spend. So they save and invest their savings in the business. The workers (who are the principal consumers) do not have adequate purchasing power to buy the goods produced by the expanding business enterprises. This results in overproduction, a fall in prices, and a depression in the economy. Thus, too much saving and too little consumption is the cause of business depression according to his theory.
Some other economists of socialist convictions point out that the real source of the difficulty lies in the fact that wages do not rise as fast as commodity prices in periods of technological progress or cyclical boom. This gives rise to excessive profits for the industrialists who invest them again or the further expansion of business. The output, thus, increases at a more rapid rate than the worker’s expenditure on consumption, resulting in overproduction, fall of prices, and business slump.
The theory has been criticized on three grounds. Firstly, it does not offer a comprehensive explanation of the business cycle. The business cycle is indeed a very complex phenomenon. It cannot just be explained in terms of a single cause- over-saving or under-consumption. Secondly, the theory does not explain why depression occurs at fairly regular intervals. Thirdly, the theory assumes that the savings of the rich automatically find their way into investment in industrial equipment. This may not be the case. Savings will be invested into industrial equipment only if it is profitable to do so. In other words, it is the prospects of profits and not the mere existence of savings that governs investment in a capitalistic economy.
Comments (No)