One of the most pernicious and widespread economic fallacies is the belief that consumption is the key to a healthy economy. We hear this idea all the time in the popular press and casual conversation, particularly during economic downturns. People say things like, “Well, if folks would just start buying things again, the economy would pick up” or “If we could only get more money in the hands of consumers, we’d get out of this recession.” This belief in the power of consumption is also what has guided much of economic policy in the last couple of years, with its endless stream of stimulus packages.
This belief is an inheritance of misguided Keynesian thinking. Production, not consumption, is the source of wealth. If we want a healthy economy, we need to create the conditions under which producers can get on with the process of creating wealth for others to consume, and under which households and firms can engage in the saving necessary to finance that production.
It’s tempting to say that this is really a “chicken and egg” problem; after all, what good is it to produce things if there’s no one there to consume them? The way out of this circle is to recognize that we only have the power to consume if we have produced and sold something in order to acquire the means to engage in consumption. Starting the analysis with consumption assumes one has already acquired means. Contrary to that analysis, wealth is created through acts of production that rearrange resources in ways people value more than alternative arrangements. These acts are financed with savings that come from households refraining from consumption.
Putting more resources in the hands of consumers through a government stimulus package fails precisely because the wealth so transferred ultimately has to come from producers. This is obvious when the spending is financed by taxation, but it’s equally true for deficit spending and inflation. With deficit spending the wealth comes from producers’ purchases of government bonds. With inflation it comes proportionately from holders of dollars (obtained through acts of production) whose purchasing power is weakened by the excess supply of money. In neither case does government create wealth. Nor does consumption. The new ability to consume still originates in prior acts of production. If we want real stimulus, we need to free up producers by creating a more hospitable environment for production and not penalize the saving that finances them.
Blames It on Keynes
Historically it was Keynesianism that brought the emphasis on consumption into economics. Before the Keynesian revolution the standard belief among economists was that production was the source of demand and that encouraging saving and production was the way to generate economic growth. This was more or less the correct understanding of Say’s Law of Markets. (See also James C. Ahiakpor’s article in the current Freeman). As J. B. Say himself wrote in the early nineteenth century:
[T]he encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone furnishes those means. Thus it is the aim of good government to stimulate production, of bad government to encourage consumption.
Of course “stimulating production” need mean nothing more than leaving producers free to seek out profits as they see fit within the standard classical-liberal framework of law. It does not mean government should artificially benefit producers any more than it should encourage consumption.
The great irony is that leftists frequently argue that capitalism equals “consumerism.” They think defenders of free markets believe that more consumption promotes economic growth; thus we are charged with providing the ideological cover that justifies the consumerism they see as deadening lives and wasting resources. What the leftist critics miss is that economists never saw consumption as the driving force of economic growth and prosperity until the Keynesian criticisms of free markets became ascendant.
Thanks to Keynesianism, manipulating the elements of total income (consumption, investment, and government spending) became the focus of macroeconomic policy and economic development. It was the Keynesians’ theoretical framework that led to the development of the relevant national income statistics and that implicitly informs the popular arguments for more consumption.
For over 150 years defenders of free markets saw consumption as destroying wealth, and saving and production as creating it. They never argued that “stimulating consumption” was the path toward prosperity. Therefore they cannot be charged with justifying the “consumer culture.” And the same is true of twentieth-century defenders of free markets such as Mises and Hayek.
If leftist critics want to decry the focus of modern economics on consumption, they should turn their sights on the Keynesian interventionists.
You can read this article in Portuguese here