THERE'S A POPULAR misconception that, once exploded, explains why so called stimulus packages don't do what they're supposed to do. It's so popular that even luminaries like National Business Review editor Nevil Gibson subscribe to it: "Consumer spending," says Gibson in last week's NBR, "drives more than two-thirds of the overall ... economy," implying all that needs to be done to fix things is put more money in the hands of consumers and then everything will be sweet. What we need is a helicopter full of cash spraying its golden shower over the suburbs.
Simple, not to say simplistic.
As I say, Gibson's not the only one who's fallen prey to this popular yet facile misconception: you can read the same mistaken notion at Forbes magazine, Reuters, L'Express and Bloomberg, to name just a few, and closer to home at 3 News, TVNZ News, Radio NZ News, the Dom Post, the Otago Daily Times and Businessday --- all of them saying it's consumer spending that drives two-thirds of the economy, and consumer spending that must be supported. Urgently! What we need is shopping subsidies, and we need then now!
As I say, it's conventional wisdom. You can read it almost everywhere. Such a pity then that it's dead wrong. Insanely and destructively wrong.
FIRST OF ALL, as Bernard Darnton pointed out yesterday, that money put into the hands of consumers has to come from somewhere, else we're just committing another Broken Window Fallacy. As Brian Riedl points out in the Wall Street Journal,
Government stimulus bills are based on the idea that feeding new money into the economy will increase demand, and thus production. But where does government get this money? Congress doesn't have its own stash. Every dollar it injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It's merely redistributed from one group of people to another.
And who knows what that first group (or groups) would have done with it? They sure as hell wouldn't have thrown it out of a helicopter.
Governments don't create new purchasing power out of thin air. If Congress funds new spending with taxes, it is redistributing existing income. If the money is borrowed from American investors, those investors will have that much less to invest or to spend in the private economy. If the money is borrowed from foreigners, the balance of payments must still balance. That means reducing net exports through exchange-rate adjustments, thereby leaving net spending on the economy unchanged.
Yet Congress will soon borrow $300 billion from one group of people and then give it to another group of people and tell us we're all wealthier for it.
Lawmakers commit this fallacy repeatedly...
Yes, and so do newsmen and economists. You'll hear some of the latter group whining about something they call 'the paradox of thrift' -- they'll say that in times of recession people need to spend, spend, spend and if they don't -- if they save instead (the horror!) -- then everything will collapse in a heap. But this is just dumb. Saving doesn't mean "not spending." It simply means deciding to spend later, rather than spending it all now. And in the meantime, unless that money just goes into a hole in the ground, the money that people save goes into investment, which means it goes to producers (or would do if it weren't diluted by printing money to produce stimulus packages) which brings me to my second point.
YOU SEE, CONSUMERS don't drive more than two-thirds of the economy at all. This is just horse shit on a stick. Though it's hidden in the arithmetic of the GDP, by far the majority of spending and income payments in the economy are not consumer spending but productive spending, i.e., spending for the purpose of making sales. In other words, for the stuff that really makes the economy go round.
As George Reisman explains it, this productive expenditure constitutes "all the expenditures made by business firms in buying capital goods of all descriptions and in paying wages,"
"Capital goods include machinery, materials, components, supplies, lighting, heating, and advertising. In contrast to productive expenditure, consumption expenditure is expenditure not for the purpose of making subsequent sales, but for any other purpose. In the terminology of contemporary economics, consumption expenditure is described as final expenditure. Productive expenditure could be termed intermediate expenditure. Implicitly or explicitly, productive expenditure is always made for the purpose of earning sales revenues greater than itself, i.e., is made for the purpose of earning a profit."
And this figure is huge! It is
"an amount equal to the sum of all costs of goods sold in the economic system plus all of the expensed productive expenditures in the economic system. It is these costs which must be added to GDP to bring it up to a measure of the actual aggregate amount of spending for goods and services in the economic system... And because productive expenditure is the main form of spending, most spending in the economic system depends on saving. Even consumption expenditure depends on saving, inasmuch as saving is the basis of the payment of the wages out of which most consumption takes place."
Which means that it's not consumer spending that drives the economy at all: it's saving.
Just contemplate that for a moment.
So how can such an enormous figure be hidden in the arithmetic? Well, I blame Keynes. Essentially that GDP figure is his; when the GDP (or National Income figure) is totted up it counts profits, but it ignores completely the costs required to make those profits, i.e., it completely ignores productive expenditure, which by any rational measure is the spending that drives everything. In Reisman's words, that means that "Keynesian macroeconomics is literally playing with half a deck.
"It purports to be a study of the economic system as a whole, yet in ignoring productive expenditure it totally ignores most of the actual spending that takes place in the production of goods and services. It is an economics almost exclusively of consumer spending, not an economics of total spending in the production of goods and services."
And being an economics almost exclusively of consumer spending it sees "stimuli" only in consumer terms.
But once you realise where most of the deck of cards resides -- i.e., in productive spending -- you really do see what you're doing with consumer stimulus packages: you're taking real resources away from the behemoth that really does drive the economy, which is productive expenditure, and you're pissing it up against a wall.
That might be popular, but in the long run it's just flat-out dumb.
- The Revelation According to John - Bernard Darnton, NOT PC
- Why Spending Stimulus Plans Fail: What Congress gives to some it takes away from others - Brian Riedl, WALL STREET JOURNAL
- Standing Keynesian GDP on Its Head: Saving Not Consumption as the Main Source of Spending - George Reisman's Blog
UPDATE 1: If you would genuinely like to make sense of the wider discussion here, the clearest and most integrated pieces are these:
- Bastiat: 'What is Seen and Not Seen.'
"There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen."
- Bastiat: 'What is Money'
"I cry out against money, just because everybody confounds it, as you did just now, with riches, and that this confusion is the cause of errors and calamities without number.
- Rand: 'Egalitarianism & Inflation'
"If I told you that the precondition of inflation is psycho-epistemological—that inflation is hidden under the perceptual illusions created by broken conceptual links—you would not understand me. That is what I propose to explain and to prove." And she does!
UPDATE 2: Don Boudreaux's brilliant letter to the Washington Post has much wider relevance than just the proposed auto bailout [emphasis mine]. See if you can spot the Bastiat reference:
Martin Feldstein and George Will each offer excellent reasons for opposing a bailout of Detroit automakers (Opinion, Nov. 18). Here's another: resources given by government to these corporations must be taken from somewhere else. Government cannot conjure billions of dollars of resources out of thin air.
The number of different places from which these resources will be taken is large and spans a continent. So it's easy to overlook the fact that each of many productive firms from across the country will, as a result of this bailout, pay more for steel, machine tools, fuel, and other inputs they use in production. These other firms will contract their operations; they'll employ fewer workers; they'll produce less output.
The bailout might well save GM, Ford, and Chrysler. If so, politicians will celebrate it as "successful." But that success – which will be easy to see and capture on video tape – will likely really be an economic failure because of the resulting (if hard to see) contracted economic activity throughout the economy.
Donald J. Boudreaux