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Spending & saving

| Tuesday, July 10, 2012, 8:47 p.m.

No economic instinct runs more deeply than the instinct about the alleged supremacy of spending. It screams: “Buying more output from existing producers is key to economic health! The more spent, the better!” It's this instinct that makes reports on “consumer confidence” seem relevant. More “confident” consumers mean more freely spending consumers, and more freely spending consumers mean a healthier economy. Q.E.D — or so our instinct tells us.

This instinct is old. It's also fallacious. Like all long-lived fallacies, however, a tiny kernel of truth looms within it. That kernel is the businessperson's correct understanding that higher demand for his output is indeed good for him and his suppliers (including his workers).

From this truth, the typical businessperson concludes that higher demand for the output of all existing firms — or higher demand at least for the outputs of those firms that today sell less than they sold yesterday — is the principal cause of economic vigor.

Unsurprisingly, this fallacy leads to disparagement of savings. Every dollar that you save is a dollar that you don't spend buying bread from your local baker or beer from your local pub. The baker and bartender see that you'd spend more if you saved less. They see — perhaps accurately — that their revenues would rise if you saved less.

But what goes unseen is all-important.

Simplifying only a tad, you have two chief reasons for savings. First, you want to increase your ability to consume tomorrow. Second, you want to protect your ability to consume — your “assets,” broadly speaking — from being unduly depleted tomorrow.

Although these motives overlap each other, the first might be thought of as evidence of optimism, while the second is evidence of pessimism.

If you're optimistic, you reduce consumption today to invest in projects that, hopefully, will turn a profit and enable you to consume more tomorrow. You might invest conservatively (say, in mutual funds) or entrepreneurially (say, by opening your own business). A necessary condition for making such investments is reasonable confidence that tax rates and regulations will not be so burdensome as to devour your hoped-for gains.

An absence of confidence about tax rates and regulatory burdens remaining reasonable, though, sparks the second, very different, motive for saving: fear of the future. Fearful of the future, you sock money away. You don't commit your money to expanding existing enterprises or to creating new ones. Government policy renders such investment imprudent. You simply conserve your spending power.

Saving of the first sort enlarges the economy's stock of capital. The pie grows. Saving of the second sort diminishes the economy's stock of capital. The pie shrinks.

In both cases, saving nevertheless hurts some existing businesses. If you reduce your spending at the pub in order to save to open your own business, your bartender is harmed. But clearly your saving in this case is economically beneficial.

If, however, you reduce your spending at the pub because you become more anxious about the state of the economy, your bartender suffers no less than if you saved more to open your own firm.

It's tempting to conclude that saving of the second sort is undesirable. But resist that temptation. Saving driven by such pessimism is merely a symptom of bad policies. To blame such savings for an economic slump — or to endorse government spending as a helpful device to make up for this saving — is to miss the real culprit: unwise and imprudent policies that discourage commerce and industry.

Donald J. Boudreaux is a professor of economics at George Mason University in Fairfax, Va. His column appears twice monthly.

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