Is there such a thing as too much of a good thing

Can having an existence in a land of abundance actually have a down side?

In economic terms, the answer to both questions is yes. The efficiency of an economy is related to the way it uses its capacity to produce. When there is an over abundance of capacity (called excess capacity), the implication is that the economy is inefficient.

The Theory

The theory is that the economy is in healthy balance when the capacity utilization factor is around 80% or a little higher. If the factor exceeds 85%, the theory holds that supply will have trouble keeping up with demand and inflation risk is greater. The idea is that above 85% capacity utilization there will not be enough flexibility of production to prevent isolated supply shortages driving up some prices, which will then spread through the wider economy. This concept of supply shortages with capacity utilization significantly below 100% is said to be caused by inefficiencies in the means of production.

If the factor is much less than 80%, the theory states that the economy is suffering inefficiencies because supply (or the capability to supply) exceeds demand. In such a situation inflationary pressures should be lessened.

There is no basis for these percentage designations other than historical experience. The nature of our manufacturing centric economy of 40 and 50 years ago was much different than the current service economy. Why should 80% (or 85%) capacity utilization today have the same inflation correlations as in the 1960s and before? The answer: They could very well not be the same.

The Perelman Factor

According to Wikipedia

Capacity_utilization economics historian Michael Perelman has argued that the current economy is much more efficient than that prior to the early 1980s.

Today the new 85% capacity might be more like 90% (triggering increased inflation risk) and, using Perelman's suggested numbers, today 77% would be as much under utilized capacity as 70% was formerly. Capacity utilization is still determined by the same old process.

If Perelman is correct, to put the recent numbers on the same "stress" and "excess capacity" scales for comparison with years before the early 1980s, today's numbers would have to be reduced by 7%.

In other words, today the higher inflation risk would be experienced above 92% utilization and excess capacity would start to be experienced below the mid 80% area.

Historical Variation

It is now instructive to look at a graph from Calculated Risk , which shows capacity utilization since 1967. I have added black reference lines that define channels for 1967-83, 1983-2000 and 2000-?

Click on images to view full size.
Three times in the 1989-98 interval, capacity utilization peaked barely above the 85%.

The rest of the time in the 1983-2000 time period the level was mostly between 78% and 83%. This was a period when the economy was mostly in the classical window of optimum efficiency. And the extreme swings in capacity utilization in the time period (1967-83) and since 2000 did not occur then either.

To incorporate Perelman's contention and draw a new graph which would better show the change of capacity utilization over time relative to "normalized" theoretical stress levels, we could subtract the 7% efficiency improvement from the recent data. Then, plotted on a graph with the original data, we would see capacity utilization variation against a standard of stress which has varied over time, with that variation, in effect, factored out.

That is done in the following graph.

The 7% improvement was subtracted in uniform increments monthly over a seven year time span, from January, 1984 to December, 1990.
A caution is in order here. We are looking at an artificial construction. I do not know how well the "Perelman Factor" actually represents the true conditions.

However, it is reasonable to expect that the level of capacity utilization needed to introduce inflationary stresses should be higher in the day of such factors as just in time inventories, freedom to adjust payrolls freely without union interference, flexibility to move workloads virtually anywhere in the world at a moment's notice, etc.

If the level of capacity utilization needed to raise inflationary stress is higher, then that means the optimum level of capacity utilization is also higher. If Perelman is correct, the old 80% optimum is now above 85%. This means that the current capacity utilization of 72% is actually 13% below optimum and 20% below the level associated with inflationary pressures.

A Curse of Abundance

All this indicates that we indeed have the curse of abundance. We have excess capacity in the total economy that has not been seen in the past 40 years and probably has not been seen since the 1930s. And we did not get to this situation recently. We have been sliding steadily deeper into ever greater excess capacity for nearly 30 years.

This means that expansion of means of production of goods and services is not needed and will not occur. We must find a way to soak up an increase in capacity utilization of the order of 20% above the current level (1.2 x 72% = 86%) to get to an optimum utilization level.

Impact on Employment

We indeed have a significant burden of excess capacity on employment. Employment will increase much more slowly if we do not need to build new capacity. Investment in new means of production will not occur for some time - it is not needed.

One effect of this is seen in the historically high permanent job loss in this recession. No previous recession in the past 60 years has seen a peak in permanent job loss above 45%. In this recession the number is 56% and could still be rising.

Of the 8.8 million jobs lost in this recession, 56% or 4.9 million are never coming back.

This also has an impact on the civilian labor force which has seen a historic decline of 1.8 million. If the drop from the pre recession extrapolation is considered, the labor force shortfall becomes 4.1 million (1.8 + 2.3).

This compares to the reported loss in the civilian labor force of 4.6 million, shown in the following graph.

The half million difference could be largely attributed to retirements.

But loss of jobs and the decline in the labor force are only part of the impact of excess capacity. There has also been an increase of 5.1 million people forced to work part-time, who desire full-time work.
These are the so-called "Part-Time for Economic Reasons", shown in the following graph.

The burden of excess capacity is impacting more than 13.9 people directly, the 8.8 million increase in unemployment plus the 5.1 million "forced" to work part time.

More than 13.9 million, because I have not included the millions who are still working 35 hours a week or more, but have experienced fewer hours and/or reduced pay.

The Way Out

There are some reasons to hope this can be changed over time. If we are to address our balance payments (trade deficit), it is my belief that this must include reduced energy imports. We definitely do not have excess capacity in energy production. We do not have excess capacity in the application of genetics to disease prevention and control.

In addition we have infrastructure needs that, by being unmet, are introducing more waste and inefficiencies into our economy. And the next big economic development may not even be on our radar screens. In the 1970s almost no one could conceive of the technology revolution that drove the information age expansion which was to start in less than ten years.

But all of these paths to the way out of our overabundance will be long. I have estimated (optimistically) that it could take seven years or (pessimistically) too long to estimate.