While reading this N&O article about yesterday’s drop in the stock market, it hit me only a few lines in:
Economists say sustained drops in stock prices tend to suppress consumer spending as people see their wealth shrink. And consumer spending accounts for about 70 percent of economic activity.
The highlighted part represents one of the most universally accepted notions about our economy. But like virtually all “mainstream” economic thought, its completely wrong.
I’ve written on this before, but it certainly bears repeating. As economist Mark Skousen described:
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.
This faulty and misleading emphasis on consumer spending has been the source of destructive public policy for generations. The emphasis on “getting consumers spending again” overlooks the true foundation for economic growth: investment spending on production, as fueled by real savings.
Changes in consumer spending are the result, not the cause, of economic growth or contraction. As Jean-Baptiste Say wrote in his book A Treatise on Political Economy: “it is the aim of good government to stimulate production, of bad government to encourage consumption.”