“You can’t spend your way out of a recession.”
First, a confession. I am not a trained economist. Nor am I formally trained in medicine, astronomy, the theory of war, or civil engineering. Yet I take each of them seriously, and treat them with respect. Therefore, I am going to talk about them.
At least, economics.
It’s tragic that something so essential to the well-being of people, something they must take into consideration in one part of their personal lives or another, is given such short shrift in the course of common education. And when it is bandied endlessly in public by charlatans, quacks, and rogues, it seems criminal. Innocent misunderstanding may be forgivable, if irritating. Education, public and private, has been thoroughly negligent. But it’s unacceptable.
And how is this relevant? How does economics fall into the ‘personal’ category? If you can think of no other reason, because you vote.
Well, let’s think about that. In the U.S., exports run a little over 10% of GDP. So around 90% of our economy is what we sell to each other. Another way of saying it, is that 90% of the U.S. economy is what we buy from each other.
When we say that the economy is depressed, we are therefore saying that spending is depressed. When we look for economic recovery, what we are looking for is a recovery in spending.
And it gets worse, but you probably see it coming. When we look for economic growth, we are looking for growth in . . . yes, spending.
Now I will apologize for being sardonic. The topic deserves better. And there is an important point of confusion here, one that often comes up when people think about economics.
Academics call this confusion ‘the fallacy of composition’, but you probably don’t need to remember that, and I won’t bore you with a digression. You can digress on your own time here.
Here’s where we get confused. Everyone knows that thrift is a good thing. How could it not be? How could you possibly be harmed by wisely saving your money?
Well, you can’t. But what happens if everyone tries to save more? Suppose dark clouds are gathering on the economic horizon. It would be insanity to go out and splurge. You’re likely to pull back. And by the same token businesses will think about pulling back on investment, due to the new uncertainty.
Spending and investment together are the money flowing into businesses. (When you put your savings into the stock market, it’s not business investment because your purchase price is not going to the business underlying the stock, but we’ll talk about that another time. Just keep in mind that business investment nearly always goes through intermediaries, like banks, that receive your savings.)
Wages, dividends, etc., are the money flowing out of business and back to consumers. It’s their income.
Stay with me.
Savings normally balances investment, because all the money flowing to consumers as income balances all the money flowing from them back to business as purchases-plus-investment. But here we have a problem. People are becoming thrifty and saving more, but business is receiving less in sales and so demanding less investment. Something has to give.
It does. Business cuts back on expenditures, like salaries. Consumers receive less income, due to fewer working hours and layoffs, confirming their fears about the economy. So they want even more to save. But business wants even less to borrow, i.e. less investment.
How does this end? Well, in a simplified world without government or central bank intervention, badly. The consumer’s desire to save is eventually counteracted by the need to spend on essentials. Like food, like the car payment, the house payment, the rent, and so on. We say that ‘the propensity to save’ declines with declining income. At some point everyone is forced to spend a greater share of their income, until savings are squeezed enough to match the smaller need for investment on the part of business. We finally reach a stable point.
Of course, we reach it because we’re all poorer.
This is called ‘the paradox of thrift’. If everyone tries to save more, we all end up saving less, because we all make less, and we all have less (in the aggregate) to spend. And we’re all confirmed in our pessimistic view of life, and learn to stay thrifty.
Now, this is not a comfortable thing to think about. It seems wrong that something so obviously a virtue for the individual should become a vice in the aggregate. But it’s right. And it’s a classic example of ‘fallacy of composition’.
A modern capitalistic economy is something like a nuclear reactor. Everything is a chain reaction. It can build up dangerously hot, or dwindle until it’s cold as ash. You can’t just leave it to run itself. It needs someone to moderate it.
A nuclear reactor is not a comfortable thing to be around. But it delivers an awful lot of energy, and I for one am not willing to give up on it, nor leave it to superstition.