Surowiecki Gets Consumption Wrong

What hope is there when one of the top business journalists gets the facts wrong? In his latest New Yorker piece, James Surowiecki makes the classic mistake:

Personal consumption hasn’t shrunk as a share of the economy: in 2010, it accounted for more than seventy per cent of G.D.P., close to where it’s been for the past decade

Let’s break down what’s wrong with this statement. First, the statistical category “personal consumption expenditures” actually includes all sorts of government and nonprofit spending, including almost $1 trillion in Medicare and Medicaid spending, spending by nonprofit private educational institutions, and spending by political parties. None of this money is under the control of ‘consumers’, so there’s no possibility of individuals making the decision to cut back.

The other word that Surowiecki doesn’t mention is imports. When American consumers boost their spending on items such as clothing and electronics, much of that goes to create jobs overseas, not here. It’s devilishly tough to get the exact connection between consumer spending and imports, because the government does not actually track where imports are going in the economy. But the net result is that ‘pocketbook spending’–the amount of money that households control–accounts for much less than 70 percent of economic activity.

This is not just a semantic point. Every time somebody repeats “consumer spending is 70% of GDP’, it reinforces the false idea that U.S. growth is dependent on consumer spending returning. It’s not. I’m surprised that Surowiecki made this mistake, especially given the nature of his piece.

It’s time for me to put out a refresher policy brief from PPI on this.

Is Consumption the Point of Economic Activity?

On the Economist Free exchange blog, Ryan Avent objects to some of my recent writings on the production economy vs the consumption economy. In the process, he makes a statement  that I feel needs further examination. He writes:

consumption is the point of economic activity; why work except to obtain things?

I have heard this line before. To me, it sums up the essence of the consumption economy: The only purpose of work is to consume.

I would like to raise two objections to this statement–one technical, one philosophical. First, even if you believe that consumption is the only point of economic activity, presumably we  care about the consumption levels enjoyed by our children, and our children’s children’s. So if you care enough about future generations, you personally will choose to consume less and invest more today. Given that we as a society are running up big debts,  it is highly likely that our children will be better off if we choose to invest more today and consume fewer goods and services, whether they are imported or domestic. Under current circumstances, there is no moral imperative to consume.  

Second, I’m going to wax a little philosophical here.  Mr. Avent writes that “the only purpose of work is to consume.” That’s a little bit like the people who say that the main goal of life is to be happy. I would disagree with both statements. I would say that once we are above some level of income, the main goal of work (and life) is to contribute to society in the best way we can.  Happiness (and consumption) flows out of that contribution.

End soapbox.

P.S. I wouldn’t have any trouble at all with a trade deficit if we had a high rate of investment. But our current level of net investment, in nominal dollars,  is less than half of what was before the recession. We’re borrowing from the rest of the world to fund our consumption today, not our investment and productivity gains.

[Added on 8/17

Here is a Keynesian post that claims Consumption – To Repeat the Obvious – Is the Sole End and Object of All Economic Activity ]

 

Consumer Pullback Not So Scary

See my latest theAtlantic.com column here.

 

‘Production Economy’ vs ‘Consumption Economy’

In a recent post, I said that the U.S. should be a production economy, not a consumption economy. Matt Yglesias notes that “I have really no idea what that’s supposed to mean, since presumably the idea is to produce goods and services that people want to consume.”

Let me explain: I believe that the U.S. has come to a fork in the road. The direction we’ve been going leads to the  the consumption economy, putting more resources into consumption and distribution rather than production. It hasn’t been working for us.

The U.S. needs to change course to a production economy:  put more emphasis on investment in physical, human, and knowledge capital, and less on consumption as the yardstick of success.  We need to take up our fair share of the global productive burden.   

To see one indicator of the consumption economy  take a look at this chart.

It tracks the buildings used for manufacturing (production) versus buildings used for retail, wholesale, and warehouses (distribution). Around 2001 the lines crossed, a sign that distribution was becoming more important than production in the U.S. economy.

The goal of a consumption economy is to provide consumers with low prices and wide variety, with less concern about jobs and wages.

In a consumption economy, successful corporations are the ones who can best manage their global networks of suppliers to obtain the lowest costs. Offshoring is a mark of pride,  showing that companies can meet the desire of their customers for lower prices.

In theory, a consumption economy can be a great thing.  Low prices can presumably bring higher living standards for households, as real wages rise.  In theory, production is not an essential component for economic prosperity if you can create the product and organize the production and distribution process.

The great success story for the consumption economy is Apple. Apple is a spectacularly profitable creator of innovative  products and ecosystems, and a successful retailer to boot.  However, the company does not manufacture the  iPads, iPhones, iPods, and so forth that  it creates and sells.  Creation and distribution, but no production. [Edited for clarity. See below*]

However, Apple is Apple. For the rest of us, the consumption economy isn’t working  so well.

I promised myself I would stop writing excessively  long posts, so I’m going to stop here for now.

*Added:  The exact language from Apple’s  annual report

Substantially all of the Company’s Macs, iPhones, iPads, iPods, logic boards and other assembled products are manufactured by outsourcing partners, primarily in various parts of Asia

Obviously this does not include software.

Where Americans Can Cut Back

Where can Americans cut back if the economy slips back into recession again?  After all the talk about the “new frugality” and the deepest recession in 75 years, it might seem like households have tightened their belts as much as possible.

Surprisingly, however,  the economic figures show several key areas where Americans have actually increased consumption compared to 2006, the year when housing prices peaked.  Judge for yourself whether we can cut back more or not.   (Note: all consumption changes are measured in inflation-adjusted 2005 dollars, comparing the 2nd quarter of 2011 with the second quarter of 2006)

1. Clothing                 Consumption: + 8.9% since 2006

Despite the economic weakness,  Americans spent on clothing at an almost $350 billon annual rate in the second quarter of 2011. Nothing seems to stop the waves of inexpensive shirts, dresses, and coats  coming from overseas.  Clothing imports from China, especially, are up 37% since 2006, and Americans are snapping them up.  Perhaps we could buy a a few less t-shirts with funny sayings on them?

2. Personal care products    Consumption: +14.4% since 2006

We like to look our best, even in a recession. Perfume, makeup, shampoo,  shaving cream and razors, body gels–Americans spend about $100 billion a year on these personal care items.  Not only that, we’re spending more on imported cosmetics,  which are up 26% since 2006.  Are all those goos and gels  really necessary?

3. Televisions    Consumption: +287.4% since 2006

No, that’s not a misprint.  The government adjusts for the size of the television, among other things, and the average size screen has soared since 2006.   If we don’t adjust for size and other variables,  Americans are spending 12.7% more on televisions today compared to 2006.  Total personal consumption outlays on televisions, according to the BEA: About $40 billion, pretty much all imported.  Do you really need an even bigger TV?

4. Alcoholic Beverages (off-premises)    Consumption: +10.7% since 2006

Perhaps it’s not surprising that Americans need an extra drink these days. Still, the total home spending on alcoholic beverages is about $110 billion, at annual rates, according to the Bureau of Economic Analysis. A few less glasses might put a few extra dollars in the pocket.

Remember, all these figures apply to Americans in the aggregate. Those people who have been out of work for months or years don’t have room to cut back at all.

And remember–when journalists write that “consumer spending is 70% of economic activity,”  they are completely wrong. What the U.S. economy needs is more production, not more consumption–and in a globalized economy, the two are not synonymous at all. And that, my friends, will be the subject of tomorrow’s post.

Vampire Meme: Consumer Spending is 70% of Economic Activity–NOT!

With the holiday shopping season, we’ve seen a revival of the confident but completely wrong assertion:  “Consumer spending is 70% of U.S. economic activity.”  No matter how many times I stab this vampire meme in the heart, it just keeps getting back up again. There are two reasons why it’s simply not true that consumer spending is 70% of economic activity:

* Consumer spending, especially this time of year,  includes a lot of imported goods. So when you buy a toy, a shirt or a big screen TV, just flip it over and look at the label– your money flows out of the country to stimulate economic activity in China, or Korea, or Mexico.

* The government’s definition of consumer spending includes Medicare, Medicaid,  and money spent by nonprofits such as political parties and religious groups.

So when you see  pictures of Americans buying toys, clothing, and consumer electronics, think about happy workers around the world. U.S. consumers drive global economic activity.

For some of my other posts on the subject, see here and here.

Hall of Shame–news organizations who got it wrong.

For at least 15 years, 70 percent of economic activity in the U.S. has come from consumer spending. Atlanta Journal Constitution

The surge pushed stocks to a new two-year high, as retailers, economists and investors, while cautious, were encouraged that consumers—who account for 70% of the U.S. economy—are again opening their wallets. Wall Street Journal

Consumer spending accounts for 70 percent of economic activity. Associated Press

Retail sales are closely watched as a measure of consumer spending, which accounts for about 70 per cent of economic activity. Financial Times

One Sign of Deflation

I’m not ready to commit myself yet to one side or the other of the inflation/deflation argument. Part of me thinks that we are heading for a massive dollar depreciation, which would lead to an inflationary squeeze. Another part of me thinks that we are short short short on consumer demand.

Here’s a data point in favor of the deflation argument. As part of my previous post, I calculated personal consumption expenditures, subtracting out education, health, and housing. Education and health have big government support. Housing also has government support–in addition, much of housing PCE is imputed rent on owner-occupied housing, so does not reflect actual out-of-pocket outlays.

So this chart shows the 10-quarter percentage change in PCE, ex health, education, and housing.

Consumer spending today is *lower* than it was at the beginning of the recession, outside of education,healthcare,  and housing. What’s more, the growth rate has been on a steady downward trend.

This is not simply an artifact of population growth. The per-capita graph looks just the same.

What does this all mean? Just as the government-supported health and education sectors  have been the main source of  new  jobs since 2000, so has health and education (and housing) been the main support for consumer spending.

Ladies and gentleman,  we’re at a turning point. Assume for the moment that we need to combat deflation. Should we accept the long-term trend, where the government becomes the main driving force for the economy? Or should we do everything we can to revivify innovation and private sector growth, and fight deflation in that way?  Are Keynesian policies the only way to deal with deflation–or can we leverage new technological capabilities and innovation to create demand a different way?

Where Americans Are Spending More..

Since the recession started in the fourth quarter of 2007, the common theme has been about Americans cutting back on their spending. But the latest numbers from the BEA show aggregate personal consumption expenditures are up 2.9%, or $285 billion.  So we must be spending more on something!

So here is a table of winners: Some goods and services which have shown an increase in spending since 2007IV.

Right there up at the top is America’s love affair with mobile devices, where spending has soared almost 17% since the recession started.  Also supporting my thesis of a communications boom–spending on wired, wireless, and cable services have risen by 5%.

In addition, Americans still care about their pets, their children, their hair, and their guns.

Of course, the data also shows a big gain in spending on education, healthcare, and housing, but it’s impossible to know how much of that increase is actually coming out of the pockets of households. Education spending includes government tuition aid and spending by private nonprofits out of their endowments and contributions; healthcare spending including Medicare, Medicaid, and employer-paid insurance; and housing includes a huge imputation for owner-occupied housing, which may or may not correspond to an actual increase or decrease in out-of-pocket spending.

Once we take those three huge categories out of the data, the remaining PCE has actually gone down by 0.6% since the recession started.  So now let’s look at a table of losers: Selected categories of spending that have gone down.

Americans are spending a little bit less on clothing and hotels; a lot less on foreign travel, video and audio equipment (think televisions), and furniture. The big drop, though, has come in motor vehicles and associated goods and services, like gasoline.

No, It’s Not 70% of Economic Activity

I might as well turn this into a monthly feature. In response to today’s personal income report, Martin Crutsinger of AP writes:

Consumer spending is closely watched because it accounts for 70 percent of total economic activity.

No, it doesn’t, Martin. Every time a journalist says that consumer spending accounts for 70 percent of total economic activity, he or she is misleading readers into believing that the U.S. economy cannot grow without the consumer taking the main role (see my earlier posts here and here). 

In fact, the meme “consumer spending accounts for 70 percent of economic activity” pretty much obscures all the major problems with today’s economy.

1) The ’70 percent’ meme blurs the distinction between domestic production and imports, since  a big chunk of imported goods are counted in PCE ; 

2) The ’70 percent’ meme blurs the distinction between household and government spending, since PCE  includes Medicare and other entitlement spending.

3) The ’70 percent’ meme blurs the distinction between household and institutional spending, since personal consumption expenditures includes money spent by nonprofits (best example: Political parties, which are heavily funded by corporations, fall into personal consumption expenditures) 

To finish off this rather post,  I did some calculations on the sources of growth in real PCE since December 2009.

This table shows that 47% of consumption growth since December comes from spending on import-intensive goods.  In particular,  the two biggest increases in spending came for ‘clothing and footwear’ and ‘consumer electronics and IT equipment’, two categories dominated by imported goods.  You can be sure that when Americans step up their spending on clothing, they are creating very few manufacturing jobs in this country.   

Another 13% of consumption growth came in categories where third-party expenditures are important, such as healthcare and nonprofits.

P.S. I’m getting some traction in my fight against the 70 percent meme. See Donald Marron’s post, for example.

Bad News from Personal Income Report

In today’s personal income report from the BEA,  real personal consumption was up by 0.3%, which according to many commentators was a sign that the economy was improving. Bloomberg had a short piece with the headline:  

U.S. Stocks Rise as Consumer Spending Boosts Economic Optimism

But I look at the numbers and say something very different. I see that real personal income, leaving out transfer payments, fell in February for the second straight month.  So I would have written the headline a different way:

Consumers Keep Spending Because the Government is Giving Them Money

 The private sector shows no sign yet  organically generating growth.  That is to say, the real personal income generated by jobs and private businesses and investments is falling, once we omit the effect of government transfer payments, such as  unemployment insurance, Social Security, Medicare, and Medicaid. Here’s a little graph:

Not a good sign, by my lights.

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