I have never stated that 'if you build it they will come', because that is patently false. This is a common straw man erected by the true 'aggregate demand is all' believer (I don't know if this is your position or not). If you build it, they will come is as absurd as 'if we just gave everyone a bit more money, the economy would grow'.
Look at the labor market. The US unemployment rate went from ~4.5% in 2007 to 10% in 2010: a big labor glut. The "malinvestment" theory predicts unfulfilled demand comparable in size to the unemployment. Large sectors of the economy should have had millions of unfilled job listings, spiraling wages, etc. But this did not happen.
The right explanation is simply that total labor supply exceeded demand.
If a person produces hot pink sweaters and finds nobody wants them, that doesn't mean there is a shortage of blue sweaters, or even sweaters in general. Additionally, it might mean that people might want hot pink sweaters, but not at the price being asked.
Taking this back to labor markets, surplus labor (unemployment) is indeed oversupply, that much we are agreed. But you must break this down further - it is an oversupply of specific types of labor at specific rates. You could clear that labor oversupply by switching the supply by changing the type of labor being offered, and also by changing the price. For example I'd happily pay someone to do work for me at lower rates than currently offered, but that market doesn't usually clear. Changing the price doesn't happen often for regulatory reasons or stickiness, but changing the nature of labor supply often does. It's just that the timescales involved involve a lot of problems.
The solution to that is to identify reason why mal investment occurs and to avoid anything that contributes to it. I don't think it can be totally avoided due to human nature - hubris, mistakes and misfortune - but you can certainly avoid some of the obvious ones, like rigging credit markets and trying to centrally plan economies.
For example, we Americans demand less oil today than we did 10 years ago. This contributes to the oil glut, which has turned many drill sites into malinvestments and caused layoffs in the petroleum industry. How can you say that that consumer demand is irrelevant here? Isn't it obvious that if there was a nationwide ad campaign to buy gas guzzlers and take them on road trips, it would increase oil prices and improve the state of the petroleum industry?
And if it can happen in the petroleum sector, why not at the scale of the entire economy?
Going back to a general glut - and I hate the term - of course it is possible to have an economy-wide contraction where production overwhelms demand temporarily. This is possible from external shocks (eg war, disaster) or persistent interference (eg Venezuela). Such a scenario is generally best resolved by solving the cause of the shock and doing everything to let the market clear. Most of the time this will be temporary and conditions will resolve, if not at the speed at which makes everything happy. I think the key thing here is that while there will be demand for other production at some point, it's necessarily a case of timing and there is likely to be a lag before new preferences are developed. The key here for future prosperity is not to borrow and spend on what is already not wanted, or to borrow and spend on pointless spending just for the sake of making money move.
The alternative is if an economy dropped to a new, lower level of production by choice, such as if everyone decided to lower their production and consumption and consciously not increase it again. You'd then get reversing economic growth, but then that would be the intention as results from people choosing less.
Maybe waiting would work, but that's no reason not to intervene if we think that intervention can bring us faster growth (even if this will only be temporarily faster growth until we "catch up" to currently unused production capacity). If consumption stimulus will help recovery (and I think it will, on Keynesian grounds) we should do it.
But so many people from the Marxist-leaning schools just don't and refuse to, because at its core this belief destroys pretty much every argument they make about moving from a market-based system to a collective one.
Eventually, beliefs will have to change - anything that can't go on, won't - but I don't expect it in my lifetime. Human nature is unchanging and economics is simply the study of human choice when it comes to limited resources. At some point understanding must come back to this simple point - you've got to produce something to trade for something - but magical thinking and hoping has a way of persisting for a long, long time.
Edit: you'll see that most of my comments in this topic are being systematically down voted. This is because it is contrary thinking to what gets fed in higher education in the past few decades. I know, because I consumed the same content, and had to continue my own further education to realise why the concepts never sat right with what I observed going on. And that results in a lot of a-ha moments when you start reading pre-Marxian and pre-Keynesian thought. I hold no ill-will or malice to the down voters, perhaps one day they'll come to realise the dry, barren road current macro thinking finds itself.
Actually the Marxist school of thought is one of economic self-determination.
That ideal went badly wrong with the concept of the dictatorship of the proletariat.
Even so. Economic freedom - specifically the moral right of the working classes to benefit from the economic value of their labour - is the bedrock concept of both Marxism and Socialism.
And the bedrock moral value of American corporate capitalism is the elimination of that right in favour of distribution of value exclusively to a social conceit called "capital".
Now - in fact both are oversimplified and wrong-headed, and both lead to disaster in different ways.
A useful synthesis may be possible, perhaps. But it's going to take a much more insightful analysis than anything that appeared in previous centuries.
I've never, ever seen a credible argument that saya capitalism is based on the elimination of a persons right to their labour value. That sounds terribly like some undergraduate student publication or occupy chant.
Capitalism is about the freedom to control and own capital - it's not a 'social conceit', capital refers to assets, whether physical in the for,s of factories and farms, or others, such as inventions and savings. The ability to freely allocate capital and follow ones free economic agency is the greatest engine for eliminating poverty the world has ever known, despite its obvious and some,times major flaws.
After much reading from Smith to Marx to Keynes, it's my personal beliefs that the classical economists had it right and much of the 20th century thinking was wrong. To my mind, the experiences of the 20th century pretty much lay out that case, particularly with the twin a/b test of East/west Germany.
If you want a complete history of economic thought according to he Austrian school, then 'An Austrian Perspective on the History of Economic Thought' gives a thorough background from Ancient times to now on the evolution of economic thought and how people came up with the answers to puzzles like why is water essentially valueless as compared to gold when one is life and death and the other essentially useless. Going back deep into the original philosophers and coming forward helps to understand why thinking is the way it is.
The other book I recommend for people is 'The road to serfdom' by F.A. Hayek. This gives a thorough and as-yet unanswered critique as to why socialism in all its forms fails, and why it is an inherently unstable system that always leads to dictatorships and loss of wealth (hint: feature not bug) But these speak to my own beliefs which are decidedly no longer mainstream. Like many I studied this in undergraduate and masters courses but the explanations never really settled with me so I kept on reading. If you want to understand what the mainstream economic thinking is, just pick up a Krugmsn article and keep reading because most mainstream publications are wedded to the idea that governments can plan and manipulate economies into prosperity.
Do you agree that the goal of a business is profit?
Ergo, is the prediction of profits what create production. This is the core of the capitalist system, isn't it?
If a business don't see profit in its future, the rational thing to do is decrease production and, more important, stop new investments. That means lay offs, no new hires, etc..
Less people with jobs, less people with money, less demand, less future estimation of profits. Feedback loop.
Then come the creative destruction, that is supposedly a good thing. People is more desperate, accept worse conditions, business not 'efficient' enough close, this create less competence in the market and people ready to work for less. The survivors can accumulate more claims in the economy, what means concentration of capital in less hands. Rise and repeat.
I'll reiterate: 'To buy something, first you have to produce something worthy of exchange'.
To understand this, don't immediately jump to the business level, think of it at the individual level. If I want to buy something, first I have to produce something worthwhile, so I can exchange that thing for the other. It's unlikely that the exchange is going to be direct (barter) and it will take place using the medium of currency.
I think your understanding of demand is slightly askew from the economic definition of demand.
Entrepreneurism is precisely what you have described - the creation of new products where future consumption is uncertain. It is vitally important as an agent of change in any economy - and incidentally is the first victim to central planning.
But that is incidental to the issue of requiring production before consumption. If I want something, first I have to make/do something which has value for someone else, then they can trade the thing that they made/did and that I value. We are both better off, wealth has grown. The issue here is that people think that just giving currency to one of us so we buy the thing off the other is the key to growth. When it is patently obvious that 'stimulating demand' by giving someone money can't possibly grow wealth (and the economy in the same way).
But this is not the claim. The claim is somebody trying to buy something with money create demand. We all agree that money is different of real wealth.
Even in an alleged two persons barter economy I could buy from you with a promise of something in the future. If the promise is good enough you could even start producing more.
And this is not even the correct framework, because what we are talking are systemic problems in modern economies that don't map well to hypothetical two persons barter economies.
I don't think that's a valid statement. There is only so much 'stuff' that you can use. Beyond a certain level more money does not translate into a better quality of life or more 'stuff' for most people, there are a few outliers but lots of very wealthy people are actually quite modest. They're so modest you won't read about them in the newspapers.
Although demand in the economic sense sort-of-sounds like want - certainly I'd like a new Lamborghini - I have zero effect on the demand for lamborghinis.
The level of spending (poverty vs wealth) is mostly irrelevant because that's a value line someone draws on a graph somewhere. Poverty in the Midwest is not the same as poverty in Sub-Saharan Africa. Absolute Poverty (in which a person has insufficient resources to survive) has a wide variety of causes but essentially reduces down to the inability of an individual or family to produce enough to exchange for what they need.
Savings are just postponed consumption in the same way as debt is the promise to hand over your future production.
Savings are just postponed consumption, but if the consumptions of multiple people never align (you could save until you're dead) the aggregate demand will never rise to a high level.
Keynes had to kill the idea that production is the foundation of growth in an economy. He did this by implanting the idea that production is irrelevant, all you needed as spending (the fantasy of aggregate demand). This was further pushed by the universal declaration that savings were a problem because it was postponed - rather than transferred. Once this foundation was laid, the idea that throwing more money at people would increase wealth was created, and enthusiastically adopted by politicians who could use it as an excuse to throw money around in good times and bad.
Savings are the foundation of future production, and future production is the foundation of future wealth. This is so self evident it takes a high level of internal contradictions to believe it not to be so.
What you are saying sounds so easy, but if it were, there wouldn't be recessions or liquidity traps. You're right that production is key, but if the monetary system becomes friction in between producers and consumers, then problems can arise even if production is okay. I don't really see a contradiction here. Savings are the foundation of future wealth, but if nobody spends any money, businesses crumble, and capacity is lost. When people decide to spend again, it takes time for the economy to recover.
The issue is you'd have to - and get everyone else to - understand that periods of high interest rates and periods of low wages would periodically happen. But people expect wages to never fall and are conditioned to fixed interest rates. As lowering wages is unacceptable the solution is to cut positions, which arguably makes things worse as no job is worse than a lower payment on an existing job. So we are doomed to business cycles for the foreseeable future.
The key thing I believe most people miss is that they believe that 'economic stimulus' in terms of under priced interest rates, government borrowing and foolish spending and other tricks comes at no cost. But there is a very real cost, and that is misallocated production - building value-destroying 'bridges to nowhere' and burdening of future income with excess taxation to repay debt.
There are those who say that a sclerotic economy - such as most countries have had for going on 7 years now - is better than a short, sharp contraction. You can compare the experiences of Japan - flat growth for two decades - or countries like Estonia and Latvia which had massive contractions but bounced back to strong growth relatively quickly. How much that impacts the safety and stability of society may be related to social cohesion and personal savings.
Probably the best answer is that governments keep a rainy-day-fund, and when credit contracts due to external shocks, the government gives a temporary tax receipts holiday and spends the savings. Such a strategy would allow people to have confidence going into an economic contraction but wouldn't indebt the government to the future. But it is fantasy-land to expect any politician to design such a scheme and resist the temptation to raid it for votes.
To buy something, first you have to produce something worthy of exchange. Everyone has to start from this point.