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 ]


China Imports: SF Fed Research Misses the Point

Recently the San Francisco Fed released a new study  entitled “The U.S. Content of “Made in China””.  The study argues that “[g]oods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010.”  This figure was cited approvingly by a large number of publications and bloggers,  including the LA Times, the WSJ,  Fortune, The,  and  Matt Yglesias,  who writes:

When Americans go buy stuff, they’re overwhelmingly buying things that are made in America:

Sorry, Matt. I’m going to explain why the SF Fed study shouldn’t be taken seriously. In fact, the study has two main flaws:

  • The authors did not distinguish between dollar shares and quantity shares of imports. When imported goods are much cheaper than domestic goods, then the quantity share can be much larger than the dollar share.
  • The input-output tables used by the authors contain no actual information about how much of Chinese imports are going to personal consumption.  In fact, all imports are  divided among sectors by a simple rule known as the “proportionality assumption.”  So in reality,  Chinese imports could constitute much more of PCE–or much less–than the SF Fed economists calculate.

Dollar Shares versus Quantity Shares

So first let me explain the difference between dollar shares and quantity shares. I’ve just finished the second edition revision of my intro economics text, Economics:The Basics.  When explaining the basic concepts of supply and demand to students, it’s always important to clearly differentiate between quantity (as measured in physical units) and cost (as measured in dollars).  The same cost  can correspond to higher or lower quantities, depending on the price.

The same distinction applies to Chinese imports. It is clearly true that Chinese imports are priced lower per unit than the domestic-made products that they replace.  Similarly, China-made imports are much cheaper than the Japan-made or European-made imports that they replace–that’s why U.S. retailers changed their sourcing over the past ten years.

As a result,  if we measure the share of Chinese-made products in PCE, our answer is going to be much different if we calculate the dollar share, versus calculating the quantity share. An example will make this clear. Suppose that a U.S. shirt factory sells 100 shirts at $50 a piece, for a total cost of $5000.  Now suppose a Chinese manufacturer comes into the market and offers to sell an identical shirt for $5 a piece. In the first year, the Chinese manufacturer sells 50 shirts and the American manufacturer sells 60 shirts.  What share of the market do the Chinese shirts have?

Measured in dollars,  the Chinese have 7.7% of the market ($250/($250+$3000)).

Measured in quantity of shirts,  the Chinese have 45% of the market (50/110)

Which share is right?  For sizing the  impact of imports on U.S. jobs and manufacturing, the quantity share is much more relevant than the dollar share.

In fact, it’s very easy to construct examples where the dollar share of imports goes down, but the quantity share goes up. If China offered its imports to the U.S. for a near-zero price, then China’s dollar share of the U.S. would be close to zero (assuming that there was some U.S. manufacturing left) but the quantity share would be close to 100%.

The authors of the SF study are calculating the dollar share, not the quantity share.  That’s why their number seems so low.

In order to calculate the quantity share, we need to know the relative price of Chinese imports compared to equivalent U.S. products. It would also be useful to be able to compare the price of Chinese imports with imports from other countries.  (See a recent article in the  Journal of Economic Perspectives, Offshoring Bias in U.S. Manufacturing). It makes an enormous difference whether Chinese made imports are 5% cheaper than the equivalent U.S. products, or 50% cheaper.

However,  the Bureau of Labor Statistics does not collect such relative price data across countries.  At  no point does the BLS measure the difference in price between a shirt made in China versus one made in Italy or the U.S.  In fact, when the sourcing of a particular  good changes from one country to another,  the import price index often treats it as a new product, even if it is functionally identical.  (Take a look at the BLS explanation of its import price methodology here).

Proportionality Assumption

The second problem with the study is that the government statisticians have no information–repeat no information–about whether an imported goods or service is going to consumption, to capital spending, or being used as an intermediate input.  How could they? That question is never asked on any economic survey form.

Here’s the description of the problem from the official BEA ‘bible’,  Concepts and Methods of the U.S. Input-Output Accounts

Unfortunately, data on the use of imports by industries and final uses are not available from our statistical data sources. Thus, to develop an import matrix, we make the assumption that imports are used in the same proportion across all industries and final uses.

This is what’s known as the “proportionality” assumption. The proportionality assumption is *not* harmless, especially when it comes to calculating the contribution of a single country, such as China, to PCE (see for example the paper here).  It might very well be that Chinese imports are much more concentrated in PCE than the proportionality assumption suggests, especially in areas such as computers where the Chinese are more likely to have a low-end product (Best Buy does not sell U.S.-made supercomputers, do they?)  Or Chinese imports could go much more into investment goods than anyone realizes. The point is that there is no information to make a judgement.

So the calculations of the SF Fed economists are fundamentally based on a huge assumption which may or may not be true.  At a minimum, they should  have offered up their calculation as a range.

BTW, if the SF Fed economists still are prepared to defend their calculations, I’m happy to debate them in any forum.

‘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.