Sunday, February 19, 2012

Quote of the Week from Of the Influence of Consumption on Production by John Stuart Mill (h/t Russ Roberts of Cafe Hayek):
In opposition to these palpable absurdities, it was triumphantly established by political economists, that consumption never needs encouragement. All which is produced is already consumed, either for the purpose of reproduction or of enjoyment. The person who saves his income is no less a consumer than he who spends it: he consumes it in a different way; it supplies food and clothing to be consumed, tools and materials to be used, by productive labourers. Consumption, therefore, already takes place to the greatest extent which the amount of production admits of; but, of the two kinds of consumption, reproductive and unproductive, the former alone adds to the national wealth, the latter impairs it. What is consumed for mere enjoyment, is gone; what is consumed for reproduction, leaves commodities of equal value, commonly with the addition of a profit. The usual effect of the attempts of government to encourage consumption, is merely to prevent saving; that is, to promote unproductive consumption at the expense of reproductive, and diminish the national wealth by the very means which were intended to increase it.
What a country wants to make it richer, is never consumption, but production.

Nearly 200 years ago, Mill recognized the faulty logic in trying to stimulate wealth by encouraging individuals to increase consumption. Sadly this lesson remains unlearned, as far too many public policies today are directed at subsidizing consumption (ie. autos, houses, oil). What is worse, a great deal of discussion regarding this topic blatantly ignores that two types of consumption even exist. Partially due to this omission, incentives to consume are often directed towards the unproductive type.

At an early age I was taught the virtues of saving and the potential benefit of compound interest. It strikes me as odd that this lesson, generally taught to children, is reversed for adults on the macro scale. Holding large amounts of outstanding debt (auto loans, mortgages, student loans, credit cards) has seemingly become the norm and an expected outcome for many individuals. Compound interest works against the borrower, raising the level of outstanding debt and reducing chances of ever paying down principal balances. (This appears to be precisely how the private sector can maintain a positive savings rate while the ratio of private debt to GDP continually increases.)

The Great Recession was largely influenced by a massive accumulation of private/household debt that could not be repaid or refinanced when assets values, most notably homes, turned lower. Increasing the nation’s wealth, for more than a couple years, will not be attained by stimulating unproductive consumption. Policy discussion must now shift to encouraging a healthy level of saving and greater focus on reproductive consumption.   

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