Hey everybody, it’s that time of year again! Black Friday is upon us, and that’s just the start of the frenzy that is the holiday shopping season. And with the season come the perennial claims that it’s your patriotic duty to go out and spend as much money as you can afford to. How else are we going to stimulate the economy and make sure everyone has a job for next year?
Not to be a Grinch, but I’m afraid I’m here to bust a hole in the common misconception that consumer spending is good for the economy. As counterintuitive as it might sound, saving, not spending, is the primary instrument of economic growth.
The idea that spending is necessary to keep the economy running dates back to the Great Depression, when British economist John Maynard Keynes came up with the wildly popular theory that recessions were caused by insufficient demand, which was itself caused by irrational impulses on the part of consumers which he called “animal spirits.” In order to get the economy running again, he reasoned, it was necessary to artificially increase demand somehow, so that merchants could continue selling their goods. For this reason, Keynes encouraged government spending as a substitute for consumers, believing that the treasury could pick up the slack by doing what ordinary people were unwilling to do: spend a lot of money.
We see the remnants of Keynesian policy in today’s economic stimulus packages, make-work schemes, and “shovel-ready” jobs programs. The nature of economics as a study dealing with human behavior precludes the possibility of scientific testing, so even though these programs don’t work, it’s difficult to prove that empirically, and so they persist in spite of their ineffectiveness.
But a little logic can shed light where statistics only leave us in darkness. In order for economic growth to occur, one of two things must happen. You have to expand the economy by adding more people to it, or you have to make the labor of existing producers more productive. The biggest gains in the standard of living have come in the wake of labor-saving inventions such as the assembly line or the microchip. And so the question becomes, how do we keep increasing productivity?
Spending is obviously not the answer. When consumers spend money on something they want, it is true that this creates a net increase in value, but in the aggregate, the potential for growth is quite small. Most people value their money more than the things they could buy with it, or else they would already have bought them. Urging them to spend due to some misplaced feeling of patriotic responsibility will not do much to make them value products more and cash less. More goods and services may change hands, but if these are not actually improving the lives of consumers, then we really just see money moving in a circle, with no net benefit.
Now, imagine that instead of spending all that money, people held onto their savings in bank accounts or the stock market. Suddenly, this money becomes available to investors and entrepreneurs. Maybe an established company needs to take out a loan to build a new factory, thereby increasing production potential. Or maybe an inventor has a new idea that he needs to finance, an idea that could make automobiles more efficient or improve computing power. The excess flow of cash into savings will drive down interest rates and make it easier for those who need a loan to get one, and it is through these major capital or research investments that productivity actually increases.
The more funds that are available to be invested in this way, the more rapidly improvements in efficiency may be made, and the more quickly the economy can grow, providing lower prices, more jobs, and better consumer goods for everyone in the country — indeed, the world.
This is not to say that you should become especially austere this holiday season, depriving your family of the gifts and food that makes this time of year so special. If it brings you or your loved ones pleasure, and if you can afford it, by all means buy it. But don’t succumb to the propaganda that endlessly spending money will improve your lives, or the economy as a whole. It’s a strategy our government has bought into for nearly a hundred years, and the result is $20 trillion of debt with little to show for it. Prudence and fiscal responsibility, blended with the occasional indulgence, will go a lot farther towards ensuring a happy life than the wanton extravagance encouraged by our political and intellectual leaders.
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