Tuesday, November 3, 2009

Increases In Consumer Spending Do Not Make Us Better Off

Contrary to popular belief, increases in aggregate spending (e.g. consumer spending) is not what leads us to a higher standard of living. Nevertheless, both in good times and bad, consumer spending is the gauge the media focuses on as a barometer of how we're doing; but consumer spending is only a measure of short-term demand. Increases in standard of living, however, come from our ability to do our jobs more efficiently.

For example, consider a plant that employs 1000 workers and makes one widget per day. Suppose one day the plant manager comes up with a new method of making that widget, and only requires 500 workers to do it. The remaining workers just got richer, because now the revenue from the widgets sold is spread over fewer workers. (In practice, of course, this process would take time, and the higher profits would be shared among owners and labourers through market forces. Furthermore, the 500 laid off workers would undergo short-term difficulties until they could join a company that's expanding.)

The aggregate nation-wide level of these efficiency improvements is referred to as productivity growth. Here's a look at US productivity growth (in percent) over the last 60 years:

Productivity numbers are reported every quarter, but are not given the attention they deserve. Government policy should be geared towards encouraging productivity gains, which come from savings which leads to investment. Instead, governments often focus on increasing consumer spending, which causes short-term pick-ups in demand (and therefore increases GDP and reduces unemployment in the short-term), but makes us no better off in the long-run.

3 comments:

Patrick said...

"Suppose one day the plant manager comes up with a new method of making that widget, and only requires 500 workers to do it. The remaining workers just got richer, because now the revenue from the widgets sold is spread over fewer workers."

Uh... What? Revenue goes to the owners, not the workers. The workers don't get richer unless they get a raise, or there's deflation.

Saj Karsan said...

Hi Patrick,

You are right - it doesn't happen without a raise. But in a competitive labour environment, that raise will come in most cases. In low-skill jobs (e.g. jobs that pay minimum wage), there is a large supply of labour, but most American jobs are not of that nature. In most jobs, workers get paid a competitive wage based on how productive they are. Workers in the plant that requires only 500 workers can in effect command twice as much pay; otherwise, someone else will open a plant and lure the workers away.

Christopher Pavese said...

Hallelujah!!

Would someone please tell Uncle Ben and his Sidekick Timmy that encouraging American consumers to take on more debt to buy poorly made domestic autos (or even well manufactured foreign autos for that matter) and still-overpriced homes, does not quite address the underlying structural problem in our economy.

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