Last month, the WSJ had an opinion piece written by Howard Dean, the Democrat presidential contender. One paragraph exhibited the fundamental fallacy of bad economics: the belief that consumption, not production, is the key to wealth.
“As president, my economic policies will be focused and clear. I will begin by repealing the 2001 and 2003 tax cuts, and using the revenues that result from the repeal to address the needs of the average American, invest in the nation’s infrastructure and, through tax reform, put money in the hands of those most likely to spend it.”
Let’s put aside the criticism of raising taxes. Let’s put aside the objection to “addressing” through initiated force “the needs of the average American,” etc. What gets my goat is two aspects of the last part–that we need to “put money in the hands of those most likely to spend it.”
First, all money is spent. There aren’t any hands into which money goes but isn’t spent, except maybe the hands of Ma and Pa Kettle, who put money under their mattress. Everybody else either saves it or spends it on consumption.
Aside from Kettle-hoarding, money that is saved goes into the bank or into investment. Money that goes into a bank is also either spent on consumption (as in financing housing or vacation loans) or invested.
Dean does not seem to realize that investment funds are spent! But even the simplest example shows this. Suppose I have $100 that I will either spend on a big dinner or invest in advertising my mailing list HBL. If I invest it in advertising HBL, I spend the money.
The difference between consumption expenditures and investment expenditures is not the difference between spending and non-spending. It is the difference between spending on something that is not for the purpose of making a profit vs. on that which is. It is the difference between spending to use up material goods and services, leaving nothing (except the memory of a great meal, in my example), and spending to use up material goods and services that produce wealth–i.e., that make a profit–i.e., that expand the stock of goods and services in the world (since profit is the excess of the monetary value of the output over the monetary value of the inputs consumed in creating that output).
So, second, it is not consumption-spending that expands wealth but investment-spending. Obviously, it is consumption-spending that Dean wants to promote. Since the relatively poor save a smaller proportion of their income than the relatively rich, what is needed for the economy to progress is for the rich to be able to keep more of their income. Economic progress is not the only thing that matters, but I assume that economic progress is what the subject of Dean’s proposal concerns. If so, what he should be advocating is: tax breaks for the rich.
Economic progress would mean leaving (not “putting”) more money in the hands of Bill Gates and less in the hands of “the average American.”
