Judd W. Patton, Ph.D. (Biography) Bellevue University Online
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Better to Save or Spend? The Ants Still Have It Right

With consumer debt at an all-time high, the nation fighting its way out of a recession, and Congress and the Executive branch debating how best to stimulated the economy, Professor Judd Patton offers some "old virtues."

Dr. Judd W. Patton
Associate Professor of Economics, Bellevue University

     In 1803 classical economist Jean-Baptiste Say (I767-1832) concluded in his book, A Treatise on Political Economy: "It is the aim of good government to stimulate production, of bad government to encourage consumption." Mr. Say, known for his proposition that salable supply is the source of demand (Say's Law), had the causation right. Consumer spending grows out of production, not vice versa.

Plain Words

     My conclusion up front in plain words: Saving is a virtue at all times but especially during a recession. Recovery from the current recession will occur with more savings rather than with more consumer expenditures! To believe that consumer spending is the key ingredient to economic recovery is a major fallacy and myth, the "conventional wisdom " of economists notwithstanding! Indeed, economists are the main purveyors of the myth.

     "Conventional wisdom" today says "Spend, spend, spend, and shop until it hurts," to get our economy rolling again. But this shortsighted approach has it precisely backwards. It is not our patriotic, civic duty to spend money and run our credit cards to the limit! Binge buying and living beyond our means is always a bad idea. It is economic nonsense.

     Like Say, Ben Franklin's Poor Richard had it right, "A penny saved is a penny earned." Saving has never been a vice, and thrift is always a virtue. 

The Economists' War Against Thrift

     It's important to understand the rationale behind anti-thrift, and the economic principles and appropriate public policies needed to shorten the recession. Today's anti-saving mentality is not new. It has been propagated throughout the history of economics, but it was 20" Century British economist Jobe Maynard Keynes, considered the father of macroeconomics, who made this heretical anti-saving thought into conventional wisdom.

     Most economic textbooks today continue to highlight what they call the "paradox of thrift." While savings are important for individual wealth creation, paradoxically, they reason, if an entire nation decides to save more during a downturn, this additional savings will only make matters worse and actually undermine recovery. Employers will downsize in response to declining consumer demand. Thus, individual savings in uncertain times will only deepen the recession, increase unemployment, and decrease Gross Domestic Product (GDP).

     Although this logic appears to make sense, it is actually economic nonsense! Frugality in uncertain times is appropriate. An "ant mentality" rather than a "grasshopper mentality" is called for.

Flaws in Anti-Saving View

     According to our Keynesian, demand-side friends, if savings are invested, fine, no problem. However, if savings are hoarded or if financial institutions do not invest savings, aggregate demand or total spending declines, weakening the overall economy. Keynesians contend that the "grasshopper mentality" of "spend, spend, spend" fiscal policy and "print, print, print more money" monetary policy is called for in response. But Keynesians fail to comprehend the true nature and extent of savings and investment in a market economy.

Saving is Spending

     In actuality, saving is spending and there is much, much more of it than Keynesians realize, being misled by their own GDP statistics, which measure a nation's output of final good and services. GDP excludes intermediate products and spending by entrepreneurs- the goods-in-process sector of the economy.-the natural resource, manufacturing and wholesale stages in the production process. Because consumer expenditures are usually two-thirds of GDP and investment is usually only 15% to 17% of GDP, many economists and media pundits wrongly conclude that consumer spending is more important than investment spending, which depends on savings. This is simply wrong. Savings may be invested directly by the saver in a business, for example, or indirectly invested by the saver's bank. In any case the savings are spent. To save is to spend.

Tracking Gross Output

     In the year 2000, Austrian economist Mark Skousen, President of the Foundation For Economic Education, persuaded the U.S. Department of Commerce to tabulate and publish a new statistic they call Gross Output (60). Conceptually, this is a much better indicator of the actual production process. GO is defined as GDP + Intermediate Input, the latter including the sale of products in the natural resource, manufacturing, and wholesale markets.

     Skousen's simple equation clearly shows that savings and investment, not consumer spending, are the driving force behind economic prosperity, just as Say's Law tells us. Gross business investment is substantially larger than consumer expenditures, contrary to Keynesian thinking. In 1998, for example, business investment was 52% of GO while consumer spending was 38%.

     Logically, production must precede consumption or consumer spending. Say was right. It is savings and productive investment by entrepreneurs that lead to wealth creation and make consumption and consumer spending possible. Macroeconomists don't under this, however, because they ignore the continually changing price system that coordinates market activity. 

     It is the entrepreneur, using savings and price information, who drives the economy. And it is entrepreneurs who must lead any recovery from a recession!

Lagging Indicators

     Business cycle research has shown that retail spending and other measures of consumer spending are actually "lagging indicators" of economic activity. The U.S. Commerce Department's Index of Leading Indicators correctly focuses instead on investment- oriented data like the stock market, manufacturing inventories, plant and equipment orders, and raw material price changes. At any rate, empirical data have always shown that consumer spending starts declining after a recession has already begun.

     The genesis of the 2001-2002 recession has been traced to March 2001. Conversely, consumer spending picks up after the economy bottoms out and begins to recover. Recovery is sparked, not by consumer spending but by future-oriented entrepreneurs who find ways to pull their businesses out of recession.

     Keynesians seem unable to see how the Leading Indicators index contradicts their worldview. Because they and other macroeconomists don't understand the cause of the business cycle, they advocate precisely the wrong policy solution.

Role of Fed Policy

     Our current recession, deepened by the events of September 11th, is caused by the Federal Reserve policy of money and credit expansion, guided by the myth to maintain total spending. "Printing more money" falsifies and artificially lowers interest rates. Had real savings occurred, lower interest rates would have given entrepreneurs correct signals upon which to base their decisions.

     The Fed's easy money policy misleads entrepreneurial decisions into ventures and projects that distort the production structure. Production decisions get out of sync with consumer preferences.

     The bottom line is that there are insufficient real resources and savings- land, labor and capital - to complete all the projects that have been induced by the credit expansion. The inevitable result is a cluster of entrepreneurial mistakes known as a recession. Eventually, fearful of the price inflation it has caused, the Fed "tightens-up," and interest rates increase and recession follows. The Fed then turns its attention to the recession, pumping in more money to "maintain aggregate spending" and artificially lowering interest rates again as they have, in fact, done since January 2001.

     What the economy needs for recovery and healing is to let the withdrawal effects wash out the unprofitable investments generated by the Fed's credit expansion. Laissez Faire! Don't interfere. Let the stock market and all other prices, costs, wages, and interest rates adjust to real market conditions of supply and demand. Then, and only then, will entrepreneurs, using real savings, lead the recovery process where the economy will once again be fitly joined together with "right" economic relationships. In short order, consumer spending will "pick up" out of the new production and additional employment, a la Mr. Say.

Saving for the Future

     Savings are always future-oriented. Savers save for many reasons: to retire, to start a new business, to take a vacation, to buy a new home, to plan for educational expenses, etc. In prosperous times most higher savings rates come from higher wages, higher profits, or higher rental income. Thus, consumer spending grows hand in glove with the higher savings rates. This is in accord with the historical evidence that those nations with higher savings rates have higher GDP and consumer spending than those with lower savings rates.

     It's really a choice between spending/borrowing now to buy consumables or investing in things that create wealth and jobs and real economic growth and, ultimately, a better future. If American's decided to spend less and save more, then certainly, many retail firms will have to cut back and lay off employees. But this is already happening in today's record consumer debt/near-record low savings rate environment.

     Saving more will make more resources available to expand production and jobs and to lower real interest rates in what economists call the "higher stages of production"-firms producing goods more distant from the retail stage. These capital goods industries expand with their more distant payoff expectations. Higher saving rates indicate more demand for future consumption.

Investing in the Future

     Entrepreneurs put the savings, and the resources it can buy, to work in new research, inventions, processes, technology and other productivity- enhancing innovations. When completed these investments, along with higher profits and increased payrolls, lead to more and better quality consumer products and a higher standard of living. Of course entrepreneurial misjudgments always occur but generally their insights and calculated risks are amazingly accurate. And so savings, along with successful entrepreneurial perceptions, lead to growth and progress.

New Circumstances

     Finally, consider the scenario and response to macroeconomists who worry about savings that are "hoarded" and/or not invested during a recession or depression. Again, they confuse cause and effect. Consumers do not save more or save at greater rates because they are irrational. Hardly! Some people have cut back their air travel due to a fear of terrorism, for example. Other industries such as hotels and motels and tourism naturally see declining demand. Others, fearful that their jobs may be in jeopardy, tighten their economic belts. They should.

     The economic point is that the economy needs to adjust to the new circumstances and new consumer preferences, the sooner the better. Economic healing will occur more quickly by forcing the hard decisions to liquidate, declare bankruptcy, cut costs, sell off assets, etc., and looking for new investment opportunities. As these decisions are made the recovery begins. Here is where any additional savings is extremely valuable. The so- called "hoarded" savings and excess bank reserves will begin to disappear as the disharmonies and economic dislocations are removed from the economy. The last thing the economy needs is "stimulation" of consumer spending or aggregate demand which would delay the economic changes the economy is going through and divert vital savings for new investment that is essential to restore a sound foundation for future economic growth.

Advice to President Bush:
More Thrift, Less Spending

      The old virtues of reducing consumer debt, of increasing savings, and of cutting back expenditures in hard times are the right medicine for Americans in 2002. President Bush should pressure the Fed to cease and desist the printing of money; let the market adjust, and not interfere by encouraging consumption or subsidizing or bailing out unsound businesses and investments. A tax cut makes sense, especially the capital gains tax, and any other tax relief is appropriate, so long as government spending is cut accordingly. Thrift, tax and spending cuts-a stimulus package worthy of its name!
     Jean-Baptiste Say's 200-year-old words resonate:

"It is the aim of good government to stimulate production, of bad government to encourage consumption."

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