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November 05, 2013

Entitlements, Savings, Spending, and Prosperity

Over the past few days, la Princesse du Blog has seen several interesting items about the relationship between a social safety net (entitlements), saving, consumer spending, and economic growth. In the first item, Alan Greenspan claims to be surprised (and 'initially skeptical!) at the relationship between entitlement growth and declining household savings:

In his new book "The Map and the Territory," to be released on Tuesday, Mr. Greenspan, 87, goes on a hunt for what has gone wrong in American politics and in the U.S. economy. He doesn't blame the current administration for today's partisan divide. The culprit? "It's the benefits," he says, pointing to the disagreements between Republicans and Democrats over how to deal with the growth of entitlements.

In the book, he also ponders why the Fed failed to predict the financial crisis, where he himself went wrong and how that discovery has completely changed his worldview.

Mr. Greenspan's biggest revelation came one day about a year ago when he was playing with gross domestic savings numbers. What he found, to his surprise and initial skepticism, was that an increase in entitlements has closely corresponded to a decline in the country's savings. "We had this extraordinary increase in benefits, with each party trying to outbid the other," he says. "That practice has been eroding the country's flow of savings that's so critical in financing our capital investment."

For the life of us, we cannot imagine why it would surprise anyone that having a social safety net would reduce a nation's savings. The old maxim about "saving for a rainy day" makes a lot less sense if households know they can pass the costs of that rainy day to their fellow taxpayers. Deferring immediate gratification is generally the kind of thing people do because they have to, not because they naturally want to. A social safety net lessens the future cost of not saving and makes present consumption seem more affordable.

On to a related item from the Chinese, who are scrambling to create a social safety net so Chinese consumers will save less and spend more:

China is trying to rebalance its economy away from investment and exports towards consumption, which Beijing hopes will deliver more stable long-term growth for the world's second-largest economy.

The problem, say strategists, is that China's consumers remain elusive.

"China is still sitting there with the lowest consumption to GDP [gross domestic product] ratio in the region. Consumption is 35 percent of GDP and is a good 25 percentage points from where it should be," said Paul Gruenwald, chief economist, Asia Pacific at Standard and Poor's Ratings Services.

"The Chinese authorities know this, they know they have to get all the social safety nets in place so they can reduce precautionary savings and get SMEs [small to medium enterprises ] to pay dividends [that could encourage spending], it's just proving to be very difficult," he told CNBC Asia's "Squawk Box."

...Consumption was the largest overall contributor to economic growth in 2012, accounting for 51.8 percent, while investment contributed 50.4 percent.

However, consumption as a proportion of GDP is much lower than other major economies such as the U.S. where it accounts for about 70 percent of GDP or regional neighbor India where it makes up roughly 60 percent of GDP.

During October, the Blog Princess was traveling most weekends. We usually fly out of Baltimore, and the week before last were delighted to have nearly perfect weather (and a correspondingly perfect view of the city and surrounding areas) both on takeoff and landing. Looking out at the constantly changing landscape is something I never tire of.

Baltimore is not one of the more prosperous cities on the Eastern seaboard, but it has gotten noticeably more affluent looking (at least from the air) over the last 20 years. Looking at the orderly structure of streets, neighborhoods, schools, retail and industrial parks, I couldn't help but be struck by how much cooperation (and peaceful conflict resolution) is needed for a city to thrive. We chose to dwell in a semi-rural area, but we can afford to do so because our jobs are in the city. This conflict resolution process is playing out right down the road from us, where a big developer is planning a huge PUD (planned urban development) where farms used to dot the landscape, punctuated by a few houses here and there. Along the route I take to work, almost every home has bright yellow signs posted prominently that read "Stop Monrovia Center!".

I sympathize with them. We live far from DC and Baltimore because we love the gently rolling hills covered with cows, horses, burros (!) and goats. Feeling obviously runs high against the development, yet I suspect there will not be a single shot fired in anger even though most people own guns out here. Somehow, things will be settled peacefully (if not to the satisfaction of some).

As we flew, I couldn't help thinking of a pervasive theme of old movies from the 1940s, 50s, and 60s: the country bumpkin leaves home and travels to the city - often the Big Apple - in search of work. That's what concentrations of people provide: opportunities. And as things become more crowded and people work together on various endeavors, conflicts multiply (as do the laws put in place to resolve them). And each law that is created, often for reasons that seem very good and practical at the time, has seen and unseen consequences:

"Belgian iron is sold in France at ten francs, which obliges me to sell mine at the same price. I should like to sell at fifteen, but cannot do so on account of this Belgian iron, which I wish was at the bottom of the Red Sea. I beg you will make a law that no more Belgian iron shall enter France. Immediately I raise my price five francs, and these are the consequences: "For every hundred-weight of iron that I shall deliver to the public, I shall receive fifteen francs instead of ten; I shall grow rich more rapidly, extend my traffic, and employ more workmen. My workmen and I shall spend much more freely to the great advantage of our tradesmen for miles around. These latter, having more custom, will furnish more employment to trade, and activity on both sides will increase in the country. This fortunate piece of money, which you will drop into my strong-box, will, like a stone thrown into a lake, give birth to an infinite number of concentric circles."

Charmed with his discourse, delighted to learn that it is so easy to promote, by legislating, the prosperity of a people, the law-makers voted the restriction. "Talk of labour and economy," they said, "what is the use of these painful means of increasing the national wealth, when all that is wanted for this object is a Decree?"

And, in fact, the law produced all the consequences announced by M. Prohibant; the only thing was, it produced others which he had not foreseen. To do him justice, his reasoning was not false, but only incomplete. In endeavouring to obtain a privilege, he had taken cognizance of the effects which are seen, leaving in the background those which are not seen. He had pointed out only two personages, whereas there are three concerned in the affair. It is for us to supply this involuntary or premeditated omission.

It is true, the crown-piece, thus directed by law into M. Prohibant's strong-box, is advantageous to him and to those whose labour it would encourage; and if the Act had caused the crownpiece to descend from the moon, these good effects would not have been counterbalanced by any corresponding evils. Unfortunately, the mysterious piece of money does not come from the moon, but from the pocket of a blacksmith, or a nail-smith, or a cartwright, or a farrier, or a labourer, or a shipwright; in a word, from James B., who gives it now without receiving a grain more of iron than when he was paying ten francs. Thus, we can see at a glance that this very much alters the state of the case; for it is very evident that M. Prohibant's profit is compensated by James B.'s loss, and all that M. Prohibant can do with the crown-piece, for the encouragement of national labour, James B. might have done himself. The stone has only been thrown upon one part of the lake, because the law has prevented it from being thrown upon another.

Therefore, that which is not seen supersedes that which is seen, and at this point there remains, as the residue of the operation, a piece of injustice, and, sad to say, a piece of injustice perpetrated by the law!

This is not all. I have said that there is always a third person left in the back-ground. I must now bring him forward, that he may reveal to us a second loss of five francs. Then we shall have the entire results of the transaction.

James B. is the possessor of fifteen francs, the fruit of his labour. He is now free. What does he do with his fifteen francs? He purchases some article of fashion for ten francs, and with it he pays (or the intermediate pay for him) for the hundred-weight of Belgian iron. After this he has five francs left. He does not throw them into the river, but (and this is what is not seen) he gives them to some tradesman in exchange for some enjoyment; to a bookseller, for instance, for Bossuet's "Discourse on Universal History."

Thus, as far as national labour is concerned, it is encouraged to the amount of fifteen francs, viz.: - ten francs for the Paris article; five francs to the bookselling trade.

As to James B., he obtains for his fifteen francs two gratifications, viz.:
1st. A hundred-weight of iron.
2nd. A book.

The Decree is put in force. How does it affect the condition of James B.? How does it affect the national labour?

James B. pays every centime of his five francs to M. Prohibant, and therefore is deprived of the pleasure of a book, or of some other thing of equal value. He loses five francs. This must be admitted; it cannot fail to be admitted, that when the restriction raises the price of things, the consumer loses the difference.

But, then, it is said, national labour is the gainer.

No, it is not the gainer; for, since the Act, it is no more encouraged than it was before, to the amount of fifteen francs.

The only thing is that, since the Act, the fifteen francs of James B. go to the metal trade, while, before it was put in force, they were divided between the milliner and the bookseller.

The violence used by M. Prohibant on the frontier, or that which he causes to be used by the law, may be judged very differently in a moral point of view. Some persons consider that plunder is perfectly justifiable, if only sanctioned by law. But, for myself, I cannot imagine anything more aggravating. However it may be, the economical results are the same in both cases.

What surprises me in all of this is how hard it was for Alan Greenspan, a famous economist who has spent all his life thinking about the intersection between markets and public policy, to see the unseen effects of maintaining a social safety net. But also, how hard it is for conservatives like myself to imagine a world they have never lived in: one in which households save for a rainy day but - because they have no social safety net - don't spend enough to support the local economy, forcing producers to transport and sell their wares overseas at greater cost and less profit.

Tradeoffs, again. No one seems to be very good at assessing them.


Posted by Cassandra at November 5, 2013 08:48 PM

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Comments

I wonder if the core assumption here is right. There's something about it that bothers me.

The little town I live nearest has not even one stop light, just a four-way stop. It has a town hall that is an empty building with folding chairs and tables stacked against the wall, open once a year or so on election day for voting only.

But I learned last night that it used to be bigger. It had a Ford dealership, banks, a furniture store... all back in the era when people saved instead of spending.

Of course in those days people thought of a car as a kind of investment -- a capital investment, which would enable them to work at a better-paying job further away, perhaps. Furniture was even an investment, not easy-to-assemble-but-short-lived IKEA-style furniture but heavy stuff made with wood and leather. It was going to be with you for a while.

People didn't consume as much, and they saved more in those banks that aren't there anymore, and there wasn't yet the safety net. But the town was bigger, and stronger, and the things people bought were made to last. That's something China has never had, and just getting to spending-more-on-breakable-stuff may not get them to the stability they think it will.

Maybe increased consumption by itself is not the answer.

Posted by: Grim at November 6, 2013 11:43 AM

Well, let's look at the effect of the safety net there:

Employer benefits are MUCH higher now than they were back in our parents' time. You can see this in the military, where there are all sorts of allowances and services that simply didn't exist in my parents' time.

I think of this every time I read about stagnant or declining wages over time: wages are only part of the total compensation package. It costs employers far more than just the given wage to take on an additional worker. This puts America at a comparative disadvantage with the rest of the world, because the cost of regulation AND benefits is passed onto consumers in the form of higher prices.

We're more productive than most of the rest of the world, but that can only make up for so much added to the costs of production. China's costs of production are far lower than ours, so they're able to flood our domestic market with inexpensive consumer goods.

The other part I meant to mention was a subject dear to your heart - the death of the kinds of jobs men have traditionally filled. For a long time, manual labor was still cheaper than machines, but add in the cost of wage floors, unions, and govt. mandated benefits and all of a sudden replacing people with machines looks downright attractive.

In my local supermarket, most of the cashiers have slowly been replaced with self service registers. It started slowly with 2 or 3, and now there are more unattended registers than ones with cashiers. And how many gas stations have someone out there pumping gas?

I agree - COMPLETELY - that increased consumption is *not* the answer. Especially consumption made possible by credit, and that's what our distorted economy has relied upon for years: household dissaving. It's not healthy or sustainable in the long term.

My point wasn't, "we should be more like China", or "hey look - the safety net's not so bad!", but more that there's probably an equilibrium point between those two opposing models.

Posted by: Cassandra at November 6, 2013 12:33 PM

Well, the linked article from Bastiat is actually instructive on savings as well.

Savings is not a net negative on production and the economy. But rather a positive. Money saved is not idle, it just is that part that isn't seen.

Posted by: Yu-Ain Gonnano at November 6, 2013 02:25 PM

Here's why I found the China thing interesting.

The standard conservative thinking on savings has been:

1. Household savings are good because they make families more resilient in bad times and minimize dependence on public resources and entitlement programs.

This seems so obvious that it shouldn't require saying, yet we see all this stuff about consumers "not spending enough" to support the domestic economy even from some conservatives. But I still believe it's true. The "unseen" part, though, is that in a service-based economy with high consumer spending relative to GDP, savings DO mean less consumption. And we tend to minimize the impact of that "unseen" part.

2. Savings are good because when households and businesses save, more funds are available for investment.

Also true, but in a global economy not all investment will be local. Other countries invest here and we invest overseas. There seems to be a somewhat naive assumption that if we just increase savings, then business will boom. But I'm not sure that's actually true in a service based economy that imports more than it exports and whose labor costs make many of our goods uncompetitive in the global market.

Will companies start businesses in America if there's not enough consumption to support their product?

That's not actually a trivial question. Both sets of assumptions miss something that is unseen about savings.

Posted by: Cass at November 6, 2013 02:39 PM

I'm also not sure some of this thinking holds together in a credit market distorted by artificially low interest rates.

Posted by: Cass at November 6, 2013 02:40 PM

It's not consumption but production that makes wealth. Of course anyone who makes a widget needs to find someone who wants to consume a widget. But if the would-be consumer is an idler who's taking money from producers to "buy" the widget with, then his consumption isn't helping anyone. What's helping is the guy whose work produced the wealth from which the payments were taken to pay the idler.

There are always going to be some people who can't work. No one wants to send grandma down the mine after she's had her stroke. But no one should be pretending that economic prosperity can be built on the model of making as many potential workers as much like Grandma as possible. The prosperity is in spite of her, not because of her, and she is maintained out of love and mercy from the fullness of the prosperity that results only from work. (And I include capital as a symbol of a stored-up promise of future work.)

Posted by: Texan99 at November 6, 2013 03:13 PM

It's not consumption but production that makes wealth.

I would argue that it's both, really. Scores of companies go out of business every day because no one is willing to buy what they produce at a price high enough to keep them in business. One side alone won't suffice.

I'm also going to quibble a bit with this, just to be a mean-spirited poopy head (but then you *so* knew that about me!):

...if the would-be consumer is an idler who's taking money from producers to "buy" the widget with, then his consumption isn't helping anyone. What's helping is the guy whose work produced the wealth from which the payments were taken to pay the idler.

True in one sense, but potentially misleading in another. If John, our producer, takes his money and stuffs it in a mattress, producers of other goods aren't "helped" by that. If he spends his money, that helps the economy. If he invests in domestic businesses, that helps the economy. If some of his money (and the caveat is very important here - that he would not have spent or invested) is given to someone who then spends it, it is arguable that the economy might be helped more than if he were allowed to dispose of it himself.

Of course there are also moral considerations. Personally, they are more compelling to me than the "do it for the economy/do it to reduce income inequality" mantras. And I think they stand alone - it is grossly immoral to force one man or woman to fork over the fruit of their labor to support another.

But I think the economic argument (and counterargument) is less clear cut. For instance, there's no getting around the fact that we have become a more prosperous society as redistribution has increased. We have - go watch old movies from the 60s, 70s, 80s, even the 90s. The question is: to what extent (if any) has redistribution affected our increasing prosperity?

I don't think there's a simple answer to that, by the way. But I still think the moral questions are so overwhelmingly compelling that they outweigh mere expediency.

Posted by: Cass at November 6, 2013 03:25 PM

The "unseen" part, though, is that in a service-based economy with high consumer spending relative to GDP, savings DO mean less consumption.

Not really. It means less consumption by that person. However, the person (entity) with whom that money is saved will increase their consumption. That is, if I don't spend the money, but instead put it into my 401k, it doesn't get buried in Fidelity's back yard. They spend it. Total consumption is unchanged. What changes is who spends it and what they buy. Now it may be true that it doesn't get spent in the service sector, but I contend that that is not necessarily a bad thing.

And it's true that it may not be all bought locally. But the very passage you excerpted talked of the harm domestic protectionism causes.

In regards to the market distortion of artifically low credit, I thought to myself "Well, I guess Bastiat told us so".

We will suppose that there is but one plough in the world, and that two farmers apply for it.
Peter is the possessor of the only plough which is to be had in France; John and James wish to borrow it. John, by his honesty, his property, and good reputation, offers security. He inspires confidence; he has credit. James inspires little or no confidence. It naturally happens that Peter lends his plough to John.
But now, according to the Socialist plan, the State interferes, and says to Peter, "Lend your plough to James, I will be security for its return, and this security will be better than that of John, for he has no one to be responsible for him but himself; and I, although it is true that I have nothing, dispose of the fortune of the taxpayers, and it is with their money that, in case of need, I shall pay you the principal and interest." Consequently, Peter lends his plough to James: this is what is seen.
And the Socialists rub their hands, and say, "See how well our plan has answered. Thanks to the intervention of the State, poor James has a plough. He will no longer be obliged to dig the ground; he is on the road to make a fortune. It is a good thing for him, and an advantage to the nation as a whole."
Indeed, gentlemen, it is no such thing; it is no advantage to the nation, for there is something behind which is not seen.
It is not seen, that the plough is in the hands of James, only because it is not in those of John.
It is not seen, that if James farms instead of digging, John will be reduced to the necessity of digging instead of farming.
That, consequently, what was considered an increase of loan, is nothing but a displacement of loan. Besides, it is not seen that this displacement implies two acts of deep injustice.
It is an injustice to John, who, after having deserved and obtained credit by his honesty and activity, sees himself robbed of it.
It is an injustice to the tax-payers, who are made to pay a debt which is no concern of theirs.
By artificially lowering credit we have not created economic activity, but displaced it. And as you have said, repeatedly, prices are signals. They are data.

One cannot be surprised that people make bad decisions when they are given bad data. And so we displace good economic activity with bad, because we are being lied to. Because someone else thought we were too dumb.

Posted by: Yu-Ain Gonnano at November 6, 2013 03:36 PM

Whoops, didn't close the "href" tag properly. It was supposed to end before the blockquote.

Posted by: Yu-Ain Gonnano at November 6, 2013 03:37 PM

If some of his money (and the caveat is very important here - that he would not have spent or invested)

Who are these people who are not spending nor investing 100% of their money. Even money put into a checking account is invested. Do you really think the banks are just letting that money sit there gathering dust? Even the people buying physical silver and putting it in a safe "spent money" to obtain it in the belief that it is a worthwhile investment.

Unless people are, quite literally, stuffing cash into their mattress, for all practical purposes, everything is spent or invested. Even the money given to poor stroke victim Granny. She will either spend or invest it.

There is no pool of money gathering dust that may be transfered to someone else who may spend or invest it. There are only two places where such money exists: 1) Your walking around money in your wallet. 2) Capital reserves which are required, by law, to do so {which, even then, may be held in low yeild liquid investments}.

Posted by: Yu-Ain Gonnano at November 6, 2013 03:55 PM

I would like to save more, but I don't have a lot of places to put my savings.

Posted by: Man Riding Unicycle Naked at November 6, 2013 04:22 PM

Joe produces value for which he is paid 10 dollars. If he spends it on $10 worth of food for Grandma, the economic effect is the same as if he spent it on himself to buy socks. The economic effect is not multiplied because he gives the money to Grandma instead. Is Joe really drawing a complete blank on any other goods or services that are available in the economy (or any investment in a growing business)? If he can't spend the money on Grandma, is he really going to burn the $10 in a barrel in the backyard? In the real world, he's either going to spend it on socks or he's going to hand it to a bank who will loan it to an interest-paying customer, or he's going to hand it directly to an interest-paying customer. (Or if not literally interest, then some kind of return on capital.) Even if he hides it in his mattress, it will be for the purpose of pulling it out next winter for socks.

It's not demand that fuels an economy, it's demand that's backed up by value which the demanding person is willing and able to part with. We don't create demand out of thin air any more than we create value out of thin air, by redistributing assets. We just change the name of the person who is willing and able to part with the assets.

The money is nothing more than Joe's right to save up a chit with which he can demand future goods or services, instead of having to barter for an immediate pair of sox the same day he does his work.

Posted by: Texan99 at November 6, 2013 05:08 PM

Who are these people who are not spending nor investing 100% of their money.

I'm pretty sure money deposited in foreign banks (Cayman Islands?) does nothing to affect American consumption or investment.

Posted by: Cass at November 6, 2013 05:15 PM

I would like to save more, but I don't have a lot of places to put my savings.

MRUN - was that you in Sly's latest caption contest? I had no idea you were that nimble!

/running away :)

Posted by: Cass at November 6, 2013 05:16 PM

Tex:

1. There's no sense in arguing that if he spends the money here at home, there's no difference because specifically excluded that from the argument I was making :p

Actually one might argue that marginal dollars are be spend differently depending on the income level. For instance, the last dollar for a relatively poor person is more likely to be spent on the basics - food, clothing, shelter - than it is on luxury items. So from an economic perspective, who has the money absolutely does shape the market. Imagine a world in which (God forbid) we taxed the rich until they were no better off than the much-vaunted "near poor". It would be a different economy b/c no one would have money for luxury goods or nonessentials. It would also be a crappy economy, I think.

But that's not really the point I wanted to make - it's just an aside. I don't think different uses of the same money are necessarily equivalent from an economic perspective.

The economic effect is not multiplied because he gives the money to Grandma instead.

That wasn't my argument.

If he can't spend the money on Grandma, is he really going to burn the $10 in a barrel in the backyard? In the real world, he's either going to spend it on socks or he's going to hand it to a bank who will loan it to an interest-paying customer

Ah, but will it be an American bank? That's not where a lot of wealthy folks keep their money.

That matters to our economy. Of course foreign banks may lend their money to American firms, and American banks may invest/lend money to foreign enterprises. But there are higher risks associated with lending to people in other countries. I don't imagine many small businesses, for example, are funded with dollars invested overseas.

Even if he hides it in his mattress, it will be for the purpose of pulling it out next winter for socks.

Not if he's one of the filthy, Chinese toy-loving capitalistic running pig-dog members of the richest 1%, he's not. Rich people don't spend nearly all their money. That's why they're rich :p

Tex, you're treating the domestic economy as though it were a closed system. But it's not anymore. If we could wall off all "our" money, I might agree with you. But that's not the case in a global economy.

Posted by: Cass at November 6, 2013 05:27 PM

I'm pretty sure money deposited in foreign banks (Cayman Islands?) does nothing to affect American consumption or investment.

Sure it does. The Cayman Island Bank is lending/investing that money the exact same places Wells Fargo is. That money does not collect dust. Each bank consumes my money as a substitute for me. Whether WF invests my savings in IKEA, or CIB invests my savings in IKEA, or I invest that money directly myself, the result is exactly the same. IKEA increases production with that capital and sends the profit home to me. I not only have more money with which to spend and/or invest, but everyone else (foreign and domestic) have cheaper goods available which also makes them richer.

Posted by: Yu-Ain Gonnano at November 6, 2013 06:04 PM

I accept your correction (after having more time to think about it, I pretty much said that in my response to Tex). But I'm not sure that "nothing", "something" and "exactly the same" are equivalent.

I not only have more money with which to spend and/or invest, but everyone else (foreign and domestic) have cheaper goods available which also makes them richer.

Yes, but if this is the case why is China having the problems it's having? Imports and exports don't have the same costs or effects. I don't think we can say they're equivalent.

Posted by: Cass at November 6, 2013 06:08 PM

Oddly enough, what Yu-Ain refers to (cheaper goods available in a global economy making our wages worth more in terms of buying power) is something I've written about a few times wrt the oft-quoted "stagnant" wages/household income over time.

Most of these factors have offsetting effects - it's not a simple case of "flip this lever and that lever will respond by 10%...20%... whatever %. The relationships aren't linear. That doesn't mean there are no cause and effect relationships (I hope that's obvious) but the same change in different conditions will have different results.

Posted by: Cass at November 6, 2013 06:12 PM

I don't imagine many small businesses, for example, are funded with dollars invested overseas.

Not directly. But foreign banks will lend to American banks, who will then lend to American Small businesses, and vice versa. My 401k invests in foreign banks which do lend to foreign small business. Therefor, by substitute, so do I.

Posted by: Yu-Ain Gonnano at November 6, 2013 06:14 PM

Is your argument that a safety net (a/k/a wealth redistribution) would help the economy because it's better for people to spend money on basics than on luxuries? And that we should make rich people give money to poor people so the money will be spent on goods instead of invested overseas? Why not just outlaw luxuries and migration of capital directly?

Posted by: Texan99 at November 6, 2013 06:23 PM

Yes, but if this is the case why is China having the problems it's having? Imports and exports don't have the same costs or effects. I don't think we can say they're equivalent.

Several reasons.

1) It may be that the Chinese literaly do stuff money in their mattress for fear of confiscation.

2) The effects of Communism have a dampening effect on production (as producers fail to profit sufficiently or fear gov't confiscation of the business)

3) All money is "spent" or "invested" but not necessarily wisely. Interference in the market displaces efficient uses into inefficient uses. To take Bastiat's example, the slacker gets the wheelbarrow and not the industrious and thus total production is lower than otherwise would be.

4) China has spent a ton of money making ghost towns no one lives in. They went around smashing the windows and thought replacing them was "growth". They are now paying for Bastiat's Broken Window fallacy.

There are a lot of reasons for China's problems that arent' tied to Export/Import ratios.

Posted by: Yu-Ain Gonnano at November 6, 2013 06:24 PM

Is your argument that a safety net (a/k/a wealth redistribution) would help the economy because it's better for people to spend money on basics than on luxuries? And that we should make rich people give money to poor people so the money will be spent on goods instead of invested overseas?

I can't imagine anything I've written that would suggest that's what I thought. This seemed pretty plain to me:

If some of his money (and the caveat is very important here - that he would not have spent or invested) is given to someone who then spends it, it is arguable that the economy might be helped more than if he were allowed to dispose of it himself.

Of course there are also moral considerations. Personally, they are more compelling to me than the "do it for the economy/do it to reduce income inequality" mantras. And I think they stand alone - it is grossly immoral to force one man or woman to fork over the fruit of their labor to support another.

Posted by: Cass at November 6, 2013 06:26 PM

All money is "spent" or "invested" but not necessarily wisely. Interference in the market displaces efficient uses into inefficient uses.

That was my point exactly. Is this not also true of our economy, which is not a truly free market?

The only difference between my position and yours is that I am willing to entertain the possibility (not saying that this is what I believe to be the case) that interference in the market could direct uses in both directions. And even if interference directed money from less efficient uses to more efficient uses, that still wouldn't justify it on moral grounds.

Posted by: Devil's Advocate, biting Yu-Ain on the butt :) at November 6, 2013 06:30 PM

Here's an example of inefficient use of redistributed wealth. Welfare recipient spends govt. check on drugs rather than food.

Posted by: Devil's Advocate, biting Yu-Ain on the butt :) at November 6, 2013 06:31 PM

I'll have more to say when i have time, but that is essentially the theory behind all command economies. That the government is better at allocating resources in a more efficient manner than the people. This is impossible but it has never stopped then from trying.

There are several reasons for this but they'll have to wait for later.

Posted by: Yu-Ain Gonnano at November 6, 2013 08:53 PM

I had always thought this was Frank Herbert in Dune but WikiQuote says it's John W. Campbell's Law of Everything: You can't do just one thing. It's a variation on Heraclitus, "You can not step twice in the same river." When you try to command the world, you discover that it's all connected.

Posted by: htom at November 6, 2013 10:13 PM

Here are the arguments that caught my eye:

"Actually one might argue that marginal dollars are be spend differently depending on the income level. For instance, the last dollar for a relatively poor person is more likely to be spent on the basics - food, clothing, shelter - than it is on luxury items. So from an economic perspective, who has the money absolutely does shape the market. Imagine a world in which (God forbid) we taxed the rich until they were no better off than the much-vaunted "near poor". It would be a different economy b/c no one would have money for luxury goods or nonessentials. It would also be a crappy economy, I think."

And whoops, clearly I did miss your point, which is (I think, now that I look at it more carefully) that it's no advantage to the economy to ensure that more people buy basics and fewer buy luxury items. So that would be an argument generally against safety nets?

"In the real world, he's either going to spend it on socks or he's going to hand it to a bank who will loan it to an interest-paying customer . . . [RESPONSE] Ah, but will it be an American bank? That's not where a lot of wealthy folks keep their money. That matters to our economy."

Still not sure what you meant there. Good or bad effect of wealth redistribution that it increases or decreases the flight of capital overseas?

Posted by: Texan99 at November 7, 2013 10:21 AM

That command economies can better allocate resources rest on a few different assumptions.

1) That gov't people are smarter than the people
2) That gov't people are noble
3) That improvement in effeciency is knowable
4) That better decisions can be made by ignoring or falsifying data (price signals)

I think 1) is false because "smart" isn't a single axis measure. Gov't people are "smarter" in that they knew more about how to gain power and could put that intellegence to work. But that intellegence may have been the best way to slaughter your opponents in the field of battle or the best way to buy votes with other people's money. None of this suggest that gov't people are actually smarter with how to manage an economy. Not even unelected bureaucrats in the Treasury department are necessarily hired based upon their abilities to manage an economy. A great many economists disagree wildly about what is best. They can't all be correct. (More on this in 3)

If anyone needs proof that 2) is false they need to open their eyes. People are not noble as a group, and gov't people are just that: People. Some are noble and others less so. And people are not nearly as careful with other people's money than their own. It is very easy to spend other people's money when doing so does not directly effect your own life.

See: ObamaCare, congressional participation in.

This, by the way, applies to corporations too. They are also collective bodies spending money not directly their own (that is the office manager buying printer paper is not doing so from their own money, but the money entrusted to them by the business) The only difference is that a corporation's money is generated willingly. Gov't takes it by force. Companies who use their money unwisely tend to not earn as much in the future. And so inefficient uses tend to be replaced with more efficient ones (though certainly not perfectly). Gov't is not so constrained. It does not need each individual person's consent for the appropriation of money. And so the incentives for efficient use are correspondingly less. Gov't people are incented to spend money not in efficiently productive ways, but in ways that keep them in power. Which is, after all, the kind of people that are attracted to those positions.

As mentioned before, 3) is clearly false as even those specifically trained have wildly divergent views. Economics is not physics where the speed of light is 299,792,458 m/s. Economics is not math where the volume of a cube is L*W*H. You have 6b people each with hundreds of wants, needs, and desires which change over time. And many of them are mutually exclusive, not only across groups, but across individuals, and not uncommonly within a single individual. As mentioned on this blog several times, there is no one thing "The People™" need. Talking about doing what's right for "The People™" is non-sensical as what is right for one is not right for the other. You might as well try to shoot a swarm of locusts and expect it to drop dead. Global maximization cannot be attained. Local maximum is the best one may hope for. But no one person or coordinated group has the intelligence to manage all the local maximum. There are simply too many of them. Before you got anywhere near enough people to manage all the local maxima, you are right back into the competing interests problem of individual management. Only now you have a large group of people *not* engaged in production who, as per 1) and 2) are doing more harm than good by actively engaging in 4).

Prices are data. For people to make good decisions they need to have good data. The only thing worse than no data is bad data. Command economies require a belief that good data leads to bad decisions. If good data led to good decisions you wouldn't need them. The problem would solve itself. Command economies take a look at prices and declare: "I know that the data says Americans want cheap disposible products and not expensive durable products, but *I* know better". And so, since the truth is inconvienient it is ignored by the managers and policies are enacted contrary to it, or policies are enacted such as taxes and/or tariffs to falsify the data to the consumer. As I said, it requires a belief that people make better decisions when they are lied to. It is too far of a stretch to believe that the people in charge are, in fact, smarter than you, are also, in fact, more noble than you, and, in fact, know exactly which lie to tell for your own good.

Too many highly improbable things must all be true simultaneously for the theory to be correct.

In theory, there is no difference between theory and practice. In practice there is a great deal of difference.

Posted by: Yu-Ain Gonnano at November 7, 2013 10:39 AM

T99,

I think the theory that China is going with (and the one Greenspan seems to have held) is that it is better that one does not spend money on basics, but rather on luxury goods.

The theory goes this way. Everyone faces risk. Let's say that risk is X% and the number of people are #Y. However, the consequence for that risk are incredibly high. Say $Z. A single person can not absorb that risk easily and therefor every single person holds back $Z from the economy to cover that risk. The Total dollar amount withheld from the economy is then #Y*$Z. However, in practice not everyone will actually experience that risk. The true amount needed to cover the risk is not #Y*$Z, but X%*#Y*$Z: a much lower number. Transferring the risk from the individual to a third party representing the group frees up the difference between #Y*$Z and X%*#Y*$Z to enter the economy. This is the premise of all insurance. One does not need to save for the entire risk, but only their probability of risk.

And this sounds attractive. Only, as we've shown earlier, unless people are literally stuffing money into a mattress, consumption is not definitionally better than savings. Savings is not a lack of consumption, it just changes the name of the consumer and what that new person consumed. And as my previous comment, the market distortions from central planners can shift that new consumption away from efficient uses to a greater or lesser extent. (Some distortion is unavoidable, infrastructure is a necessary catalyst and it must be paid for.)

Posted by: Yu-Ain Gonnano at November 7, 2013 11:00 AM

Yu-Ain,

This, by the way, applies to corporations too. They are also collective bodies spending money not directly their own (that is the office manager buying printer paper is not doing so from their own money, but the money entrusted to them by the business) The only difference is that a corporation's money is generated willingly. Gov't takes it by force. Companies who use their money unwisely tend to not earn as much in the future. And so inefficient uses tend to be replaced with more efficient ones (though certainly not perfectly). Gov't is not so constrained. It does not need each individual person's consent for the appropriation of money. And so the incentives for efficient use are correspondingly less. Gov't people are incented to spend money not in efficiently productive ways, but in ways that keep them in power. Which is, after all, the kind of people that are attracted to those positions.

To make matters worse, there are actually incentives for government to spend its money without succeeding at its task. If a company isn't meeting consumer needs, the consumers take their money elsewhere. But if a government bureaucracy isn't succeeding at its mission, the first plea to Congress will always be that they need more money -- regardless of whether or not more money will actually fix the problem, or whether their current budget is being spent efficiently or effectively. Even if those in charge aren't deliberately milking the system, they have no incentive to reevaluate whether methods they're personally, emotionally invested in are actually effective.

As for China and consumption vs savings: it sounds to me like, similar to all those empty cities they've built that nobody wants to move to (and I don't blame them -- I've seen pictures of new high-rise apartment blocks that fell over intact), the only thing left in China to invest in is production capacity with (currently) no outlet. Money in the bank may get invested, but it's only really an investment when it turns a profit, and it's hard to turn a profit when there's nobody spending money on what's produced. China's economic boom so far has been fed by consumption of their exports by the rest of the world, but if they're hitting their limits even with that, the only big group of people left to sell to is the Chinese themselves. Like Cass said, there's a balance to be found.

On the upside, if the push for additional Chinese domestic consumption leads to agitation for higher wages to pay for it all, maybe they'll stop undercutting the rest of the world's manufacturing. Yes, there will be other third-world cheap labor sites, but none as big as China.

Posted by: Matt at November 7, 2013 04:28 PM

As for China and consumption vs savings: it sounds to me like, similar to all those empty cities they've built that nobody wants to move to

And that's just it. They "spent money"/"increased consumption". What they didn't do was produce value.

Posted by: Yu-Ain Gonnano at November 7, 2013 05:05 PM

The present life style is better than the 50's 60's because of credit/borrowing or in Bastiat terms plundering the future. The City of Rome was able to keep prosperity growing by conquest and looting another country. (some by taxation of the provinces) In this day, we just borrow another year's income from the future. Rome ran out of wealthy countries to conquer and the empire began to fragment. Borrowing from the future is expensive. This is easy to demonstrate by calculating the true cost of a car or house "Principal and Interest versus the cost of saving up and earning interest to buy a car or house.

Posted by: Blick at November 7, 2013 06:52 PM

Observations:
- thanks Cass for a brilliant post, one of the simplest arguments in favor of free trade I've seen. Very.Well.Done.
- Grim, young son, Cass wasn't criticizing American savings rate, which is indeed too low long term, she was simply point out that savings rates vary a *lot* by country, and for good reason. A responsible Chinese household has no good reason to trust that their gov't will honor social safety net promises . . . they have seen in their lifetime the 'iron rice bowl' be abandoned.
- Hi YAG; net savings can and should be the source of net productive investment (basic macro-economics), yet that only occurs in jurisdictions that have a relatively free financial market. Both China, and to a lesser extent Japan, have much lower returns to investment due to gov't intervention in capital markets (Japan; Postal Savings and other 'diddling,' China gross capital and monetary intervention).
. . . and very nice anecdote on how/why gov't ought not be involved in capital markets.
- I've been to China, and you bet your ass they hide wealth from possible gov't confiscation. That's worth a series of separate posts.
- that (1) - (4) comment would make an excellent prelude to 'Macro 101' textbook. Well.Done!
- Cass again; there will be a reckoning for the Fed's huge monetary intervention, and it won't be pretty. and BTW, *all* redistribution programs have retarded economic growth; the famous Keynesian 'multiplier' is actually less than unity . . . in his own lifetime he admitted that he neglected the 'long term.' I actually support many of these programs, but it is foolish beyond absurd to think that they contribute to economic growth.
- Hi Tex, there is a fundamental difference between $10 spent on socks or given to grandma, compared to $10 invested; the investment is able to increase net productive capacity (or flipside, reduce net cost of production) . . . which increases net total supply, which drives down net prices and encourages consumers to spend more . . .

Separately, many have noted the high post WWII growth rates. There are two primary causes for that growth:
- in the aftermath of the war the only large industrial economy that wasn't damaged, or destroyed, was America.
- the impact of the JFK tax cuts is unbelievably underappreciated.

Much more complicated is the analysis of the fiscal decisions to pay down war debt (improving the monetary position, strengthening the dollar), the *huge* Marshall Plan gift/investment in Europe which helped rebuild the world economy, and large domestic investments in physical infrastructure (Interstate Highway system), which helped create a more uniform national economy.

Very Best Regards,

Posted by: CAPT Mike at November 8, 2013 12:12 AM

To return to the "follow the real value" approach: what does it mean when we increase our standard of living by borrowing and leaving the bill to our descendants? It means that we took value from other people in the present, typically in our case Chinese people, on the promise that our descendants would pay them back. It's not clear whether it's our descendants or the Chinese who will be left holding the bag--possibly a combination of the two.

But the important point to remember is that borrowing doesn't create value. Someone--Chinese peasants or someone else--had to create value via work, which we then took for ourselves and consumed. We didn't give back a present value; we gave back a promise that someone would give them something valuable in the future. As that promise is revealed for an empty sham, people eventually will stop playing the game with us.

Posted by: Texan99 at November 8, 2013 12:04 PM

The power of borrowing and lending is that it provides the incentives for changing the names of the consumers. That is all.

It is an incentive to get money out of the mattress and consumed by another person who exchanges it for productive capacity.

Investing is a type of loan. Money is transferred from one person to another on the expectation of a return in excess of the amount transferred. A loan does this in scheduled payments, and investment does this in dividends (profit payments) and capital appreciation. Neither is guaranteed to happen.

Posted by: Yu-Ain Gonnano at November 8, 2013 12:27 PM

Guys -

Due to work, I haven't been able to keep up with thi s conversation. Please forgive me for not responding to your comments. It's been a migraine week and my limited mental bandwidth has been strained just dealing with work stuff. Will try to catch up this weekend or later today after work.

Posted by: Cassandra at November 8, 2013 12:42 PM

I hate hearing that you're suffering those things, which hit you distressingly often and sound unbelievably miserable. Get better soon.

Posted by: Texan99 at November 9, 2013 06:32 PM

Hope you're feeling better soon Cassandra.
BTW, there are apparently new (?) wonder drugs for migraines, might be worth asking your doctor about treatment options.

Posted by: CAPT Mike at November 9, 2013 11:26 PM

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