Keynesian Spending vs. Personal Spending

In this post, I want to talk about two fundamentally different views of spending in an American economy.

One view of spending is Keynesian: any spending is stimulative, and so government’s (stimulative) spending helps a stagnant economy break out of its stagnation.  Further, only government has the resources to provide the size of spending stimulus needed to break a downward cycle.

Thus, if we have a Keynesian stimulus of, say, the $800 billion of an Obama Stimulus bill, or the similar-sized aggregated stimulus spending of a New Deal 80 years, or so, ago, we would expect to see a stagnating, if not sharply contracting, economy break out of its doldrums and return to solid growth.  Yet we did not, in either case.

I won’t get into things like the fact that current government stimulus spending represents future taxes, or government stimulus spending represents a wealth transfer from productive sources to unproductive targets (in the laudable, but unsatisfied, hope that the recipients will become productive), or that government stimulus spending is aimed at a temporary response, while the costs of that spending—those taxes, and debt incurred—are long-term.  The reason government stimulus spending isn’t all that stimulative is that a tax dollar collected from an individual isn’t completely spent in the first place.  Some of that dollar is retained by the government for its own purposes, and some of that dollar is simply lost to intra-government friction.  Less than a dollar makes it out the door as actual spending.

The other view of spending is that personal spending is stimulative, and that were individuals in their aggregate to spend (or resume spending), a stagnating economy would break out of that stagnation.  Associated with this view is the commonly held belief that individual saving, by not being spending, does not contribute to breaking out of that stagnation.

When an individual spends a dollar, though, that whole dollar makes it out the door.  Of course, when the individual also saves that whole dollar is saved.  None of an individual’s dollar, while it’s in his hands, is lost to intra-individual purposes or to friction.

What happens to that individual’s dollar when he spends it, or to the government’s six bits that finally get into the economy as spending?  From here, they follow pretty much the same path: an initial food purchase is made at the local grocery store, some is spent on rent or mortgage, some is spent on the car, and so on.  Each of those recipients then spend some of their parts of that original dollar: on wages, on rent, on supplies, and so on.  All along the way, each individual or business recipient also siphons off a small amount as savings.  Each of those recipients, including the wage earners, repeat this general cycle until finally that original dollar has been consumed.  In general, the original dollar that an individual spends, in all of its spending incarnations through all those recipients’ subsequent spending, turns out to be worth around $1.75 to the local economy.  That government’s six bits, following the same path, though, can only amount to a little over $1.30 for the local economy at that same turnover rate.

Consider the money that’s saved instead of spent, now.  How non-stimulative is that money, really?  In the immediate term of a dollar actually spent, it’s not stimulative.  But it is stimulative in the not too distant future: that dollar saved either is held under the individual’s mattress against a future spending need, or more likely, it’s deposited in a bank or other financial institution.  Once that dollar makes it into the bank, it becomes part of a collection of lots of individuals’ dollars, and that collection is loaned to a number of individuals and businesses—for spending.  Saved money, thus, represents not too very delayed stimulus spending by others who have borrowed the money for the purpose.

But in the end, who is really doing the spending?  Either way, whether government or individual spending, it’s the individual individual’s money that is spent, and so it’s the individual who’s doing the spending.  A critical difference is in the pathway described above that is followed by the individual’s dollar, and this difference determines how much of that dollar actually gets spent and so the final value of that spending.

A dollar taken from an individual in taxes is therefore an expensive dollar.  It represents a loss of a dollar of private saving for future spending or for future private lending for spending, or it represents a loss of $1.75 to the taxed individual’s local economy that would have resulted from his spending that dollar himself.  If that tax dollar—or the roughly three quarters of it suggested above—comes back to that same local economy, it’s only worth $1.30, a reduction in value of 45¢.

Since government spending can only come at the expense of taxing the individual, it cannot be as stimulative as the aggregation of individual spending, even when some of that individual spending is delayed through saving mechanisms, and even if that government spending comes during an economic contraction.

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