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Consumer confidence and consumer spending equal twaddle
Gerard Jackson
Every day in some paper or other an economics commentator will solemnly write about the state of consumer confidence 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.
This kind of thinking is wrong through and through. The classical economists drove a stake through the heart of this fallacy a 200 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. Consumer spending does not drive growth, never has and never will. This is a fallacy that classical economists had demolished with devastating logic.
(That none of our so-called economics commentators are acquainted with classical thinking is indeed a sad indictment of their knowledge of economics. We can blame our 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.
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. (See Friederich von Hayek, Prices and Production, Augustus M. Kelley, New York, 1967)
The economic reality is that entrepreneurship drives the economy, savings fuel it and consumer preferences, revealed through spending, steer 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 the more we produce the more we consume. There is no circular reasoning here. The source of the savings and hence the capital that raises our 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 most 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 would 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?
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 14 March 2005