It is 'common knowledge' that the consumer is 70% of the U.S. economy -- it's a figure that's used all the time in economic reporting.  Too bad it's utter nonsense.  The consumer may be 70% of the way we measure certain aspects of the economy, but it's a statistic that is so misleading as to be harmful.

As usual, I like to get back to basics, in order to cut through the bullshit that passes for economic analysis these days.  So, let's consider things from simple principles (warning: there will be some basic math):

The first important concept is how 'the economy' is measured.  Should one measure production, consumption, or some combination of the two?  On a global basis (and ignoring for the moment reinvestment and a few other items) all production is eventually consumed in some fashion.  Thus, we could claim that the consumer is 100% of the global economy. It would make a lot more sense, however, to say that consumption is 100% of production.

Now, let's add a few other important items.  It is impossible to be perfectly efficient in production, so there will always be some waste (food spoilage for example).  Also, on the basis of a group that is smaller than the entire world, one can consume more than one produces by taking on external debt.  The main catch with debt is the interest expense.  So, we're now at:  Consumption = Production + External Debt - Interest - Waste.

Finally, the primary way to grow an economy (on a per-capita basis, which is what matters) is through reinvestment of production.  It's also a good idea to save some of our production for unforeseen events and retirement.  This gets us to an equation that covers all the most important items:  Consumption = Production + External Debt - Interest - Waste - Investment - Savings.

Now ask yourself, "What is the actual goal of an economy?  What are we trying to maximize?"  The answer, of course, is wealth.  From the standpoint of our equation, wealth is measured by savings and investment.  The more you are able to save and invest, the wealthier you will be.  Increased consumption is a byproduct of a wealthy society, but not the cause of one.  Let's rearrange the terms of our equation to reflect this:  Savings + Investment = Production + External Debt - Interest - Consumption - Waste.

Now we have a useful way of looking at things, and can see the reason for the title of this post.  To put it bluntly, consumption decreases wealth, so we wish to minimize our consumption to the extent which is reasonable.  Measuring our economic health through our consumption is completely idiotic.  Economic measurements should focus on the term in that equation which increases our wealth, namely production.

One final (and important) note is that our equation indicates that debt increases wealth (to the extent that it's greater than current interest).  This is an unfortunate artifact of a 'snapshot' measurement of the economy.  The truth, of course, is that we are losing wealth through interest, while the debt will eventually need to be paid back, subtracting this amount from our wealth in a future 'snapshot'.  The effect of debt over time is therefore negative  (a net zero on principal and a loss on interest).  A more rigorous (and needlessly complex for this post) approach would indicate this, along with a better breakdown of 'savings and investment' (assets such as houses, for example), as well as a few other time-series type items (such as depreciation and earned interest).

Posted by: Hermit Dave at 01:59 PM | No Comments | Add Comment
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