Economic growth relies on production, not just spending.

By: Robert P. Murphy

Our financial press is always stuck in a Keynesian mindset, but the tendency is particularly pronounced during the Christmas season—here’s a typical article. The moral seems to be that if only consumers would go out and spend more money, the economy would grow, stores would hire more people, and workers would have more money to spend, thus completing the circle. Yet as with most Keynesian ideas, this view has things largely backwards.

The overall purpose of economic behavior is consumption, not production. We don’t have malls in order to provide people with retail jobs. On the contrary, we have malls to facilitate purchases of goods and services, and in order to achieve that goal we also need some members of the population to provide unpleasant labor at these malls. Now in order to induce these people to labor at the malls, we give them money so that they in turn can obtain goodies at the mall (or from some other seller). What I’m saying is pretty straightforward, yet to read some of the financial commentators, you would think that the real joy is having a job at the mall, and that consumers must begrudgingly spend their money in order to finance the payroll.

Why am I so confident that my interpretation of the causality is the right one? Simple: Consider the following thought experiment. Suppose one day a particular mall announced, “Starting today, all wages for people who work here will be $0 per hour, and the prices of all goods sold here will also be $0. But workers are still free to show up and work, and customers are still free to show up and shop.” Which of the two groups—workers or consumers—would go to the mall that day?

When it comes to the different components of the economy, the hard part is producing; it’s easy to consume. As the thought experiment above showed, you can always induce people to snatch up goods that have already been produced; you just need to slash their prices. The hard part is to induce workers to toil all day in order to make these goods.

The classical economist Jean-Baptiste Say’s “law of markets” summed up this concept quite nicely. Many people nowadays believe that “Say’s Law” proclaims, “Supply creates its own demand.” On the surface, that’s obviously false—if I create 1,000 self-portraits, believe me, there will be inadequate demand for them, at any price. But what Say really said was more sophisticated. The means through which the baker ultimately “demands” shoes is not so much with cash, but rather with his corresponding supply of bread. If he wants to purchase more shoes, he needs to produce more bread. Thus, if the cobbler’s sales are weak the problem isn’t a lack of “purchasing power” in the community, but really a lack of production among others in the community.

Now back to the present day: Suppose everyone were to follow the implicit recommendation in these typical news articles, and went out and spent money with complete abandon. What would happen? Retailers would see a huge upswing in their sales, that’s true. And workers in this sector would also benefit.

But the downside is that other businesses would suffer. The effect might not be obvious at first, but if the typical household spent all of its savings on Christmas presents, it necessarily would have less to spend (or invest) elsewhere. As employment grew in the retail sector, it would shrink in other sectors.

A fundamental problem with the Keynesian mindset is that it focuses almost exclusively on current consumption. When a family doesn’t spend every last penny of its wealth this holiday season, and decides instead to leave some money in the checking account, and much more invested in retirement plans and the stock market, this wealth isn’t therefore “lost” to the economy. No, it provides the savings with which businesses can invest and grow over time. Really, the household isn’t deciding between “spending” versus “non-spending,” it’s instead deciding between “spending now” versus “spending later.”

The purpose of a competitive, free market economic system is to mobilize labor and other resources in the most efficient manner possible, in order to best satisfy the consumption desires of the people. If everybody spent more on Christmas this season, that wouldn’t make us all wealthier. It would just redirect our scarce resources from other potential goods into more candy and toys. If that’s what people really prefer, so be it. But consumers shouldn’t be brow beaten into buying more stuff than they really want.