Underconsumption Crisis

An underconsumption crisis occurs when consumption demand is too weak to sustain production and employment, and other spending does not fill the gap. A declining wage share, meaning a smaller proportion of income goes to labour, can contribute to such a crisis by shifting purchasing power towards recipients who save more of their income.

Why income distribution affects consumption

The mechanism depends on who receives income, not merely on how much the economy produces.

• A falling wage share means labour income grows more slowly than total income; it does not necessarily mean that wages fall in absolute terms.
• Wage-dependent, lower-income households generally spend a larger proportion of additional income than affluent households receiving substantial property or profit income. This difference concerns the marginal propensity to consume.
• When income shifts towards recipients with a lower propensity to consume, aggregate consumption is lower than it would otherwise have been, unless other influences offset the change.

How weak consumption becomes an economy-wide crisis

In the effective demand framework, firms need buyers for their output. What reduces costs for one employer can weaken sales across the economy if it also reduces workers' purchasing power.

• Unexpectedly weak sales produce unplanned inventory accumulation, prompting firms to reduce production and employment.
• Lower employment and labour income further depress consumption. Through the multiplier, an initial demand shortfall can therefore cause a larger contraction in income.
• Higher profits do not automatically generate enough investment to compensate: firms' investment decisions also depend on expected sales and returns.
• Although saving and investment are equal in the national accounts of a closed economy, this does not guarantee full employment. Income can fall until realised saving equals investment.

When the mechanism operates, and how it can be countered

A falling wage share is a possible cause of demand weakness, not a sufficient condition for crisis. The outcome depends on changes in aggregate demand as a whole.

• Stronger investment, government expenditure or net exports can offset weaker household consumption.
• Household borrowing can temporarily sustain spending, but debt repayment obligations can constrain subsequent consumption.
• Productivity-linked wage growth, employment expansion and transfers towards households with higher consumption propensities can support demand.
• Fiscal policy, including public investment, can help sustain employment when private spending is insufficient.