April 26, 2013

Working-class spending can't fix economy

Colin Read, Everybody's Business

---- — There is a truism that American consumers drive our economy. While export-oriented countries like Canada are less beholden to the domestic consumer, this country has grown to depend on a healthy working class. Here, the working class, the young and the retired are all hurting.

We fell into a trap, cultivated a myth of the working middle class as a huge economic powerhouse. Their income fueled consumption, and consumption fueled income. This makes some superficial sense. After all, it means that a healthy middle class will allow our nation to maintain economic supremacy.

What a shame that our beliefs were misconceptions.

The root of the dilemma took hold in the 1950s. President Dwight Eisenhower promised a car in every garage and a chicken in every pot. I’m guessing the Chinese middle class is hearing the same thing. But, by the end of his term, Ike was concerned about such economic houses of cards. He warned us of the emerging military-industrial complex. Meanwhile, General Motors was telling us what was good for GM was good for the nation.

The theory is the principle of circular flow of income. The idea is that spending by consumers results in income for corporations, which translates into income for wage-earning consumers. This flow is argued to be the economic equivalent of the Energizer Bunny.

If we subscribe to this wishful thinking, we enjoy a number of false securities. We have been convinced our economy is invincible so long as we keep spending. Our consumption serves a higher purpose than the mere satisfaction of our wants and even takes on a patriotic dimension. With more middle-class consumers than in any other country, until lately, this ensures we maintain our perch as the sole economic superpower.

Meanwhile, General Motors laughs all the way to the Bank of America.

Now, I don’t want to rain on anybody’s parade, but this voodoo economics does not make sense. It is a hijacking of Keynesian economics.

Admittedly, John Maynard Keynes dealt the first round of this house of cards. He explained, quite correctly, that the spending to purchase goods provides the income to purchase the factories that produce these goods. The problem is that his theory requires that consumers want and buy what producers make, and that producers fully value the income used to purchase their goods.

But if, as we saw during this recession, consumers don’t want to buy the goods producers are making, producers reduce production, lay off workers and curtail spending. The power of the consumer class comes crashing down.

If the economy begins to spiral downward, it is compelling to hope that government can come to our rescue. Let’s say the government simply gives us money, from wherever. If they do, either we can refuse to spend it and instead save it, or we can spend it but without a matching commitment for producers to produce more. If we refuse to spend, nothing changes. If we resume spending, but producers don’t re-expand, then either prices rise or producers make greater profits but refuse to hire more workers.

We observed both effects in this recession. Households hoarded cash. This latent spending did not make it into greater investment in new factories. Meanwhile, there was no inflation. Producers feared raising prices and employees feared demanding higher wages. Yet, there is now an awful lot of cash parked on corporate balance sheets.

Government can also spur demand through tax rebates. While this additional cash allows some to resume consumption, a good fraction trickles abroad in the form of big-screen TVs and more fuel-efficient cars.

If these problems occur, economic policy fails to spur domestic income. Keynes would tell us that economic policy must not cultivate false consumerism, but instead create the type of national investment to renew its competitive position. We hear speeches about the need to rebuild our infrastructure and revitalize our economy. But precious little of our economic policy was formulated to do this.

No longer can a nation thrive based on the perpetual motion machine of consumerism. If only we could realize we don’t need that second tennis racket or those walrus-jaw bookends. We should be willing to consume to enjoy a good quality of life, but we should also think more about investing in a greater quality of life and a sustainable tomorrow.

Colin Read contributors to and has published eight books with MacMillan Palgrave Press. He chairs Finance and Economics at SUNY Plattsburgh. Follow his tweets at @ColinRead2040.