Since it is Christmas time, it is a good time to discuss its effects on the economy.  It is a common question for people to ask if Christmas shopping is beneficial to the economy.  I have discussed this before and it is a basic element of economics that is important to understand.

There is this common misconception that spending drives the economy, particularly in the U.S.  If this is the case, then surely Christmas time must give a real boost, since the average American family spends far more in late November and December than at any other time of the year.

The whole notion of helping an economy through consumer spending is one big fallacy.  It is a Keynesian fallacy.  While spending may temporarily make things look better, it only means that there will be less to consume later.

A society can only consume what is first produced.  Without any production, there is no consumption. So in this respect, the long-term consumption habits of a society are actually a decent measure of productivity, unless the society continues to save vast amounts of capital.  But it is important not to confuse correlation with causation.  Spending does not cause productivity.  Productivity is what allows us to spend.

It is also important to note that spending is not a good measure of productivity at any given time.  A society could currently be consuming more than it is producing based on previous productivity.  This will be a problem down the road.  A lack of savings and capital investment now will lead to a lower standard of living in the future.

If consumer demand were all that mattered, then virtually every place inhabited on earth would be wealthy.  Does anyone actually think that people in India and Africa are poor because they don’t have enough consumer demand?  That is ridiculous.  I’m sure most poor people would love to have big screen televisions and iPods and fancy cars.  The reason that people in a society are poor is because productivity is low.  The reason productivity is low is because of a lack of savings and investment.  The reason for the lack of savings and investment is usually due to a lack of free enterprise and property rights.

Just to be clear, there is nothing wrong with Christmas shopping and spending.  If the spending is sustainable, then you are simply reaping the fruits of your labor.  Each individual has the choice of what they want to buy and how much they want to spend.

But just as a society can only consume what it first produces, the same is generally true of individuals and families, assuming minimal government welfare.  If you produce more than you consume, then the difference is your savings.  In order to consume more than you produce, then you must draw down prior savings or else get someone to lend you the money.  The lender is counting on your future production to get paid back.  And just like a society, an individual’s long-term spending habits are probably somewhat reflective of his productivity.  If the individual consumes beyond his productivity, then it won’t be sustainable and he will be forced to cut back on his consumption.

In conclusion, while there is nothing wrong with spending, including Christmas shopping, it does not cause a boost in the economy.  If you want to spend more in the future, whether we are talking about a whole society or an individual, then you must produce more.