The economic spending fallacy

One cannot help but marvel at the pervasiveness of the misguided idea that spending is good for the economy.

The other day, for instance, an acquaintance lamented that his weekly restaurant expenses were hard on his pocket book, but he then quickly rejoined that at least his lavish dining habits boosted the economy. Such thinking is hardly uncommon. Indeed most cultural and media elite attribute upticks in economic growth to surges in spending and the opposite to reductions in spending. Presidential aspirant Bernie Sanders has gone so far as to suggest $1 trillion in public infrastructure spending over five years partly to “help the economy.”

On its face this thinking appears to make sense, but when examined it does not wash. Consider the following scenario.



Imagine that Person A spends money on a movie ticket. The money that paid for the ticket partly pays the income of person B, the worker at the movie theater. Person B then spends money at the grocery store, partly funding the income of Person C, the grocery clerk, who then spends money somewhere else, partly funding the income of Person D, and so on.

While this scenario seems to affirm that spending is the source of economic activity, digging deeper reveals otherwise. To see why, trace the spending chain back to its genesis. How does Person A first procure money to spend? He does so through his productivity and work effort. Producing something provides him income to spend. Production thus precedes income and spending.

But although identifying production as the first step is important, even that misses the more crucial point. As my former colleague JD Foster points out, while pinpointing the first step “solves the mental quandary of the chicken or the egg, economies are already in motion.” So the key, he stresses, is “the need to choreograph three processes occurring simultaneously – production, income, and consumption (spending).” That choreography is best orchestrated by the pricing mechanism, which, although not perfect, beats the alternatives.

However, our misidentifying spending as the first and most essential step has perverted that choreography and thus stunted growth.

Politicians and intellectuals, for instance, regularly justify policies like food stamps and minimum wage laws as economic stimulants, indulging the fallacy that spending fuels the economy. In reality, these policies misallocate resources, throwing a monkey wrench into the very pricing system so essential for economic decision making.

The same applies for several so-called “stimulus” packages, including those of 2001, 2008 and 2009. Multiple doses and trillions of dollars of spending accomplished nothing but price distortion, thereby choking off the possibility of a strong recovery. Indeed tepid growth is what we’ve received:

One oddity in the current recovery has been the lack of particularly strong growth periods.  Typically, there's a strong bounce back.  So far, in the 23 quarters since the recovery began in 2009 the economy has managed to crack 4 percent only four times, and only once did this occur in consecutive quarters. The average has been a pedestrian 2.2 percent.

Backward economic thinking should be obvious for anyone willing to scrutinize it. But as George Orwell warned, “We have now sunk to a depth at which restatement of the obvious is the first duty of intelligent men.”

Cross-posted at Liberty Unyielding.