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Monday, July 8, 2013

The Truth about Savings and Consumption


There are four major reasons inequality is squelching our recovery. The most immediate is that our middle class is too weak to support the consumer spending that has historically driven our economic growth.

Joseph Stiglitz, “Inequality Is Holding Back the Recovery

We regularly hear how important consumer spending is for the economy. The story goes like this: the more consumers spend, the more money circulates in the economy, which stimulates healthy job growth and profits. If people could be encouraged to go out and spend a little more of their paychecks, we’d all be better off. Remember the infamous “stimulus checks” back in 2008? Same idea.

Keynes went as far as to say that individuals saving their money may actually be hurting the economy, as saving reduces “aggregate demand” and therefore company revenue. Declining revenue can, in turn, result in a company downsizing, which compounds the problem even further. He coined this phenomenon “the paradox of thrift.” Sounds troubling, doesn’t it?

Fear not. You aren’t actually hurting anyone else by filling up your piggy bank. In fact, this consumerist viewpoint gets the story of economic growth entirely backwards. Economic activity should not be mistaken for economic growth. “Activity” is akin to the firing of an engine, while “growth” is putting more fuel in the tank. Sure, an engine seems impressive when it is humming, but what happens when it runs out of fuel?

Robust economic growth only comes from one place: savings. Not consumption. In fact, you might think of savings as the exact opposite of consumption. When you save, you choose not to consume, by definition.

To illustrate, we need only take Bastiat’s advice: look past the seen to the unseen. It is easy to see the activity caused by consumption: somebody takes their money, walks into a store, and purchases a good. The store increases its revenue.

But what happens to all of those goods and services that people have chosen not to consume by saving their money? Simple: Other people are allowed to consume them. Think of it this way: When you lend out your savings, you are essentially saying, “Here, I am not going to consume right now, so why don’t you?” Banks simply play the middleman: they stockpile lots of people’s savings and subsequently lend out lots of funds.

It takes an incredible amount of goods and services to construct a building, not just concrete and metal. It takes food, shelter, and entertainment for all of the workers, as well. A pool of savings must finance their consumption while they work on projects. Without savings, it is quite literally impossible to finance such a construction. This coordination between savings and consumption is a necessary foundation for sound economic growth.

This coordination is also why consumer lending (say, a big loan to buy a yacht) is not productive, in a strict sense. It doesn’t increase the net amount of wealth an economy. Those savings could have been used to finance an R&D project or to construct, say, factory equipment.

None of this means consumption and spending are “bad” things. They simply do not make us wealthier. After all, the ultimate goal of production and savings is to eventually consume. But to claim that consumption is the engine of economic growth is to put the cart before the horse.

Or, to rephrase: the consumption of wealth can never make you wealthier. Happier, perhaps. Wealthier, no.

  • Steve Patterson is a philosopher and author working outside of academia. He is also an award-winning video producer and the creator of The Truth About…