In virtually every news report about the economy, we hear reports on consumer spending – whether it be up or down. Consumer spending constitutes 70 percent of the economy, we are told, and therefore a boost in such spending is needed to spur economic growth. Liberal politicians also spout these lines when advocating for Keynesian spending schemes designed to "boost aggregate demand" and get the economy moving again.
Like most economic news reporting and Keynesian dogma, however, this concept is completely backwards.
As economist Mark Skousen discusses in this excellent article, consumer spending is indeed not the driver of the economy.
The truth is that consumer spending does not account for 70 percent of economic activity and is not the mainstay of the U. S. economy. Investment is! Business spending on capital goods, new technology, entrepreneurship, and productivity are more significant than consumer spending in sustaining the economy and a higher standard of living. In the business cycle, production and investment lead the economy into and out a recession; retail demand is the most stable component of economic activity.
Granted, personal consumption expenditures represent 70 percent of gross domestic product, but journalists should know from Econ 101 that GDP only measures the value of final output. It deliberately leaves out a big chunk of the economy — intermediate production or goods-in-process at the commodity, manufacturing, and wholesale stages — to avoid double counting. I calculated total spending (sales or receipts) in the economy at all stages to be more than double GDP (using gross business receipts compiled annually by the IRS). By this measure — which I have dubbed gross domestic expenditures, or GDE — consumption represents only about 30 percent of the economy, while business investment (including intermediate output) represents over 50 percent.
Thus the truth is just the opposite: Consumer spending is the effect, not the cause, of a productive healthy economy.
Skousen also reveals that it is in fact a higher savings rate that is associated with greater economic growth, because savings is what makes investment spending possible and a higher savings rate translates into lower interest rates. Lower interest rates makes it more affordable for entrepreneurs to invest.
Now contrast this revelation with government policies that discourage savings, such as capital gains taxes and inflationary "stimulus" spending that erodes the value of people's savings.
Skousen's article articulates economic lessons sorely needed by journalists, politicians, and big-government advocates alike. Read the whole thing.