US economy and the consumption myth

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US economy and the consumption myth

by Gerard Jackson TNA News with Commentary Wednesday 1 August 2001

Every day in some paper or other an economics commentator will solemnly write about the state of consumer confidence, sentiment or spending. If consumer spending is up he will declare that this is good for jobs and will spur growth. If spending is down readers will be told how depressing this is for jobs and growth. If consumer sentiment is confident this becomes a positive indicator and vice versa.

This kind of thinking is wrong through and through. The classical economists drove a stake through the heart of the fallacy of consumer spending a 180 years or so ago. Little did they realise that one Maynard J. Keynes would successfully resurrect the beast with a potent brew of abstruse conflicting fallacies whose meretricious garb would con virtually a whole profession into thinking it was being presented with something that was both original and profound. It was neither. His fallacies have brought about the ludicrous situation where growth and savings is now treated by many (all of whom are paid to know a damn sight better) as a chicken-and-egg question, with some still even arguing that savings are dangerous for and economy.

Consumer spending does not drive growth, never has and never will. This is a fallacy that classical economists had demolished with devastating logic. (That the vast majority of so-called economics commentators are not acquainted with classical thinking is indeed a sad indictment of their 'knowledge' of economics. We can blame universities for this lamentable state of affairs.) What has completely escaped these people — as well as most of their lecturers — is that growth consists of capital accumulation and not consumption. What these commentators are preaching, therefore, is the old consumption drives-the-economy fallacy. (some economists attitude towards savings and consumption border on the schizophrenic).

Sometimes a commentator refers to consumption spending as being about 65 per cent or so of total demand as evidence that consumer spending does indeed drive the economy. But even this figure is thoroughly wrong because total business spending is actually several times greater than consumer spending. It was calculated that in 1928 US consumer spending was only about 8.5 per cent of spending on producer goods. In other words, business spending on capital goods was about 12 times greater than spending on consumption.

Now there is nothing strange about this once we come to understand that the production process consists of a number of complex stages. It inexorably follows that the combined spending of these stages must exceed spending at the point of consumption. The reason this vitally important fact eludes most economists is that they deliberately exclude a considerable amount of business spending from their GDP calculations on the spurious grounds that it would be double counting to include it. The result is that gross domestic product is in fact no where near the real gross figure thus greatly exaggerating consumer spending as a proportion of economic activity.

The economic reality is that entrepreneurship drives the economy, savings fuel it. But spending on consumption comes out of production, while production comes from capital (the +material means of production) which in turn comes from savings. Hence, the more we save the more capital we accumulate thus more we produce the more we consume. There is no circular reasoning here — and there is certainly no chicken or egg question here. The source of the savings and hence the capital that raises productivity is clear to see — or should be.

You cannot consume what has not been produced and you cannot command goods (spend) without having resources. In other words, goods exchange against goods and not against money, which is only a medium of exchange. This is something the classical economists fully understood. Yet many of our present crop of economists seem completely unable to grasp the ramifications of this chain of reasoning. The whole thing would be abundantly clear in a barter economy.

The farmer grows wheat and exchanges it for other goods; the brewer makes beer and exchanges it for the farmer's wheat and other goods and so on. What each member of the community produces is his purchasing power; it is this that enables him to command other resources. We can easily see that confiscating part of the farmer's product to distribute to others in the belief that it will expand demand is patently absurd. All this process does in the short run is change the composition of demand. In the longer run, if carried far enough, such policies can succeed in expanding poverty by actually reducing demand, i.e., production.

Therefore, purchasing power comes out of production. That is why the great consuming countries are the great producing countries. How could it be otherwise? And yet American commentators are still looking towards consumption to bring about a recovery.

http://www.newaus.com.au/econ266consumption.html

-- Martin Thompson (mthom1927@aol.com), September 08, 2001

Answers

This is only logical. The horse does come before the cart.

-- Uncle Fred (dogboy45@bigfoot.com), September 08, 2001.

It's almost as if most of the talking head economists you see everywhere on TV today had never heard of Adam Smith.

-- Billiver (billiver@aol.com), September 08, 2001.

And, as a consequence of the reality cited above, Wall Street never seems to "get it" as to how unemployment works. Friday they actually seemed shocked that the unemployment rate shot to 4.9%.

The warning blast was like that from a giant bull horn, lound and clear, when major company after major company started announcing coming layoffs A YEAR AGO. The process is always the same. First big companies layoff, then the second tier starts (the smaller company that sells assembled packages to the bigger companies). They have contracts that are first filled, that's why they are second tier, and layoff later. Then--in continuation of the SAME PROCESS--the third tier comapnies, still smaller ones, who sell components to the second tier companies get hit in the same manner. And, thus, the dominoes go down.

All of this takes time. This why it is called a LAGGING indicator. And, unemployment has a momentum of its own. This is why, in the 1990-1991 recession unemployment kept rising (till it finally hit 7%) 15 MONTHS AFTER the recovery had started.

I am constantaly amazed that Wall Street never seems to catch up to this process. So many of the talking heads on C-NBC Friday seemed to be genuinely shocked.

I can only say that I am shocked. . .that THEY are shocked.

-- JackW (jpayne@webtv.net), September 08, 2001.


An axample of lag time is Motorola. Last year they announced a 20,000 layoff. This didn't mean that 20,000 employees were about to get pink slips the following Friday. It meant a little here, a little there, spread out over many many months. And, with severance packages having to be exhausted before qualifying for unemployment insurance, these layoffs are just now beginning to show up in the unemployment stats.

-- Wellesley (wellesley@freeport.net), September 09, 2001.

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