It is the Christmas season and a lot of Americans are out doing their Christmas shopping. Of course, on CNBC and other newscasts dealing with the state of the economy, we will hear reports about how strong or weak Christmas sales are. The strength of sales will be used by the pundits to determine the strength of the economy.
This is really one of the great economic myths. There is confusion about cause and effect. Consumer spending does not help or improve the economy. It is just about the opposite. A strong economy is what allows people to spend.
So while there may be some correlation between spending and the economy in the long run, spending should not be used as a marker about how the economy is doing or how it will be doing in the near future.
You can take a family budget as an analogy. Someone making a million dollars a year is most likely going to spend more than someone making $40,000 a year. But you don’t use just their spending habits to judge how someone is doing. If the person making $40,000 ups his spending from $35,000 per year to $45,000 per year, but is still making the same amount of money each year, this person is actually worse off because of the increase in spending.
The consumer can only consume what has already been produced. But for there to be future production, there has to be savings and investment to fund it. Just because there is a desire to spend money, it does not make products appear. There has to be prior savings.
I’m sure the people of Ethiopia would all love to go out and buy a big house and a 55 inch big screen for their living room. I’m sure they would love to eat gourmet meals every night. The bottom line is that most people in Ethiopia cannot do this because they simply don’t have the wealth. To ever get to this point, the country would have to adopt a system of strong property rights and the economy would have to grow to this stage through heavy savings and investment.
If you go Christmas shopping, you are not really helping the economy. You may be helping one particular person or business, but you are actually consuming goods and services away from others. There is nothing wrong with consumption if you are using money that you obtained through trade or labor. You contributed something to society and you are using your receipt of contribution to get something in return.
The person who saves his money and barely spends beyond basic necessities is actually helping the economy more. He has contributed something to society and now has a receipt for his contributions. However, he is not cashing in on it. He is leaving more for others to consume (which will mean lower prices on the margin). He has contributed more to society than he is consuming.
Again, there is nothing wrong with consumption if it is backed by prior savings. There is nothing wrong with shopping for the holidays and enjoying gifts. But if you really want to help the economy, increase your savings and stop spending as much money.