Be Thrifty for the Economy

People love to repeat claims which:

1. Are “counterintuitive.” Understanding them lets you feel superior to the rubes.
2. Allow you to signal your opposition to inequality.
3. Give you a reason to do the easy thing you wanted to do rather than the hard thing you don’t want to do.

Thus, the enthusiasm for the “paradox of thrift.”

The thought process here appears to be that if you shift incomes from investment into consumption, this will lead to more purchases. To satisfy these purchases, more factories, stores, ect., will have to be built. And how do you build those factories, stores, ect? Well, look over to our pile of capital, which we just shrank in order to increase consumption…

This isn’t to say the paradox of thrift never applies. If you have a bunch of misallocated resources, unemployed workers, unfilled homes, empty factories, stimulating demand can help. But we have historical-low unemployment. There should be no talk of “stimulus.” But you’re going to get it, because people aren’t that bright.

A much better argument against inequality is that the affluent, because much of their consumption has a Veblen component, slow productivity by giving the businesses which serve them insufficient incentives to innovate. Here’s a toy example: if a company making shoes for the lost-cost sector manages to cut costs by 20%, it will use the advantage to reduce its prices and gain market share at the expense of its rivals. They will be forced to either adapt or sink. The entire sector experiences Darwinian pressures to increase productivity. But if a company manufacturing shoes for the high-end Veblenish sector finds out how to cut its costs by 20%, it won’t reduce its prices. It still has incentives to innovate, that 20% cost reduction goes to its stockholders. But its competitors won’t feel the pinch to emulate its successes. The sector’s productivity growth will be slower.

One wonders how much higher economic growth would have been if everyone were much cheaper. Articles like this (turn off javascript to read) make you think it must be quite significant. Moral of the story: be a cheapskate. The economy needs you to.

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