Sunday, July 21, 2013

Why Do Economists Hate Consumption?

I'll admit upfront that this is an off the cuff remark I haven't thought through. I was reading Tyler Cowen's piece in the New York Times on wealth taxation. This passage struck me:

Historically, economists — including me — have generally favored taxes on consumption, on the grounds that they would do the least damage to long-term savings, investment and economic growth. Yet in some eyes, rising wealth will become a tempting target for short-term political gain. And note that while most Republicans currently oppose consumption taxes, they may dislike the relevant alternative, namely wealth taxes, even more.
Now, it is of course true that savings = investment as an accounting identity. However, the link between savings and productivity growth is far more complicated.

The reason for this, of course, is that investment can mean many things. It can mean investment in productivity enhancing equipment which is what savings proponents seem to think of and which increases overall welfare. Or it can mean setting aside ever more of our earnings to simply inflate real estate prices by flipping houses to each other. Both these things are under the umbrella of savings and investment but only one of these things is welfare enhancing.

Frankly, the emphasis on investment has always seemed to me to be influenced by a misreading of history combined with a combination of availability bias and ingroup bias. The misreading of history comes from the tendency to see the rise of capitalism in the textile mills and other machine oriented industries while ignoring that studies over the past several decades show that these large industrial enterprises don't even come close to explaining the rates of growth experienced in these years. Also ignored is the fact that the early modern world had an abundance of wealth tied up in land and industries that had been invested heavily in throughout history, like mining. Ignored is the shift in consumption patterns away from simple foodstuffs and towards tradable goods, throughout Europe people were expressing a preference for commodities like sugar and coffee and devoting more of their labor to acquire these goods and substituting market goods for household labor more generally.

Availability and ingroup biases come in two forms. First, classical economists after Smith focused too much on industrial enterprises. It is easy to see the changes being made by factories and steel plants, it is harder to notice the increased velocity of commerce that involves the little people making small purchases not produced by large industrial enterprises. While this perspective has largely been corrected in more recent economic history, the fact that large scale aggregate evidence was mostly unavailable to classical economists amounts to something of an original sin that has carried over into modern economics. The stories told, if not the evidence, continues to overemphasize the contributions of the industrialist over the butcher, the baker, and the candle-stick maker* despite the fact that the increased level of trade amongst these small time professionals probably contributed more to the rise of capitalism and the early period of remarkable growth than did the industrialist.

Ingroup biases resulted from the kind of people these earlier economists, and most modern economists, associated with. Early universities did not recruit broadly, the people these thinkers came into contact with were the up and coming investors in large enterprises. Their notion of business shows the influence of these titans of industry rather than the small time entrepreneur who was the real engine of growth but whose kids were lucky to get much formal schooling at all, much less reach university. This leads to a story told by the people that had more interest in justifying their success than they did describing the efforts of the millions of souls who made the far larger contribution to modern prosperity than they did.

There's more to the story of course, like the increased durability of machinery in this period. But the more I read economic history the more convinced I become that the largest piece of the puzzle is that wealth became more mobile, it had to be put to work. Before the modern period wealth was tied up in land, mines, and grain stores. After a number of changes it became essential to put this money to work, try to sit on your previously safe assets and your fate was to fade into irrelevance.

Which brings me back to the wealth tax. Wealth in the United States is incredibly skewed. While much of it is invested in machinery and other productivity enhancing investments another portion is invested in relatively non-productive assets such as land, commodities, and certain forms of intellectual property. Since not all forms of wealth are equal it seems to me at least plausible that a wealth tax could be growth enhancing.

My thoughts on this rest on a simple fact. The point of the economy is ultimately consumption, any investment pays off because someone wants to buy what was produced by that investment. To the extent the investment was simply being made for security, whether something as primitive as putting grain in a grainery or as complex as a financial derivative, an investment can potentially make us all poorer by taking assets out of active circulation. Ultimately, a properly structured wealth tax may make us all richer by reducing incentives to plow wealth into non-productive assets like land or gold and instead into growth enhancing machinery or human capital. The key thing is circulation, capitalism is about wealth flowing rather than staying static in a musty vault or wild expanse of private forest. This is basically what I see as the story of capitalism, a transition from static wealth and security to a consumption driven economy where investments are made simply to keep up with demand. The more wealth is redistributed in the form of income and economic activity the better off we all are. If it instead stagnates in idle luxury, or is siphoned off to those that won't use it to consume in the form of returns on real estate, consumer, or student loans the worse off we become.

This is, of course, more complicated than what could be achieved by a simple wealth tax. But I think the supply side driven economic perspective is basically wrong. Growth was driven by people trying to keep up with the increased consumption of the masses, mostly by the masses producing for each other. As a side effect this made a few people very wealthy, this form of income inequality is a natural side effect of the system and neither good nor bad. But to the extant that society changes to protect these lucky few we all become worse off, their wealth lies mostly idle and there is less need to invest in productivity since those that consume have less wealth to spend. What we need is wealth to change hands more often and for people to consume more, policy should bias income to earnings rather than savings. Unfortunately, I don't see this happening.

[Frankly, this piece needs some cleaning up, but I'll sit on it for another month if I don't hit publish now. Too busy lately.]

* I'm being a little too cute here but couldn't resist. To the extent that these professions were artisans they were probably actually losers from the rise of capitalism and the industrial revolution. The real emphasis should be on the multitude of small shops that sprung up using simple machinery and specialization of labor like Adam Smith's pin shop. This is the real story of economic growth, the small shop with cheap equipment that doesn't require a lot of savings or investment to set up. Just a small windfall for an artisan and the desire to expand operations. A dirty secret of entrepreneurship is that it isn't the result of careful husbanding of resources, more commonly it's a lucky break, like an inheritance gained earlier than expected, and a bit of local capital scrounged up rather than long term husbanding of resources. The notion of long term savings being tied to economic success strikes me as more of a medieval story fitted to medieval ethics and economic conditions than a capitalist one. The conflation of medieval attitudes towards investment with the radically different incentives provided by capitalism that seems so common in our culture is something that never ceases to amaze me. Capitalists are grasshoppers, not ants. Ants are the medieval artisans and landowners that got bought up and dispossessed by the faster and more aggressive capitalist grasshopper innovators.

1 comment:

  1. So the slump is here to stay for the foreseeable future. The consumer products the rising masses want are not made in the west. Plus nobody is really interested to see what Africa really needs...