Is the economy driven by consumer spending?
Let’s take the case of the Acme Television Corporation.
It comes out with a new wide-screen tv, for $1,000. It gets a 10% profit margin for every set sold. For every million people who decide to purchase it, Acme enjoys $1 billion in sales, and $100 million (10%) in profit. Let’s say that 5 million buy it in one year. That means Acme enjoys $500 million in profit, which it distributes to shareholders.
But what if one million potential buyers choose NOT to buy the set, and instead each one purchases $1,000 worth of Acme stock?
That means, sales are not 5 million, but 4 million, and Acme’s profits fall by $100 million, from $500 million to $400 million.
HOWEVER, Acme now has $1 billion in new CAPITAL, money they can use to hire more and better engineers, and build more efficient factories.
In one year’s time, ACME produces an even better wide-screen tv for $500. Whereas a year ago, 5 million felt they could afford to purchase the tv for $1,000, now 25 million feel they can afford to purchase a better version for half the price. That means $12.5 billion in sales, and ACME’s 10% profit margin is $1.25 billion, instead of $500 million.
Those one million people who chose NOT to buy the ACME tv, and instead INVESTED in ACME stock, did far more good for ACME than buying their tv could ever do. Not only that, they spearheaded research, development, and innovation that ACME’s competitors would have to adapt, benefitting EVERY potential tv purchaser.
I’ve simplified the numbers to illustrate the point. Slight increases in spending money, and slight decreases in unemployment, will NOT turn an economy around. And yet, Bush-Obama stimulus bills did exactly that. They were based on the idea that “rebates” of a few hundred dollars, “middle class tax cuts” that slightly increase your take-home paycheck every two weeks, and a few hundred thousand more jobs in education and State infrastructure construction projects will “stimulate” demand for Acme’s $1,000 tvs.
Don’t get me wrong. I am all for middle-class tax cuts. I’m all for more people earning as much as they can. But it is a mistake to think that their moderate increases in consumption will “stimulate” the economy or create real wealth. It is NOT what you spend today, but rather what you save and invest for tomorrow, that will determine your real quality of life.
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