Reprinted from Mises.org
I applaud the online magazine Slate for its recurring series on “the dismal science,” as they call it. Rather than boring discussions of the housing market or the NASDAQ index, economists such as Steven Landsburg and others tackle interesting issues. Don’t get me wrong, I just about always disagree with the columns. I was never puzzled as to why people walk up stairs but not escalators, I don’t think an increase in promiscuity will reduce the spread of HIV, and I’m still not convinced that a person should only give to one charity. Even so, the articles get me thinking, and that’s what’s important.
So the reader must understand that it is in this festive, jovial spirit that I proceed to devastate a recent Slate article, “The Sovereign versus the Idiot.” It is a stocking stuffed full of fallacies and plenty a non sequitur for all the family to enjoy. When I read an article like this, I am honestly humbled by how lucky I was to stumble across the wisdom of the Austrian economists. But enough preamble! On to the article’s inauspicious opening:
Economists generally salute holiday gift-giving for its healthy effect on the macroeconomy. And indeed, gift spending boosts GNP to the tune of $100 billion a year in the United States.
Granted, most economists can be morons and so perhaps it is indeed true that they “generally salute” holiday gift-giving; presumably this isn’t the fault of the Slate author. Even so, he missed a great opportunity to enlighten his readers by explaining that consumer spending does not drive the economy. On the contrary, saving, investment, and entrepreneurship are the critical components of economic growth.
Suppose the vast majority of Americans heeded the standard imperative to “put Christ back in Christmas,” and instead of shopping till they dropped, they visited nursing homes and sang carols. Would this be disastrous for the economy?
Not at all! Now to the extent that the change in preferences were sudden and unpredictable, there would be plenty of retailers with huge inventories on their hands in the beginning of December. They’d have to slash prices to unload their wares (perhaps to foreign consumers), and they would definitely regret the size of the orders they had placed with their suppliers. But the waste here wouldn’t be due to the lack of holiday retail sales per se, rather it would be due to the mistaken forecasts of the merchants in the malls.
Once everyone adjusted to the new situation, the “macroeconomy” (which I believe is synonymous with “economy”) would be just fine, thank you. Resources that previously went into the production of gaming systems and plasma screen TVs would be channeled into other lines.
After all, the money that the newly parsimonious Americans had previously spent on Christmas would now be directed to other ends. Instead of spending $200 on DVDs, a typical parent might keep that money in the bank and earmark it for college tuition. This extra savings would lower interest rates and allow business investment to increase, thus providing the “real” infrastructure to accompany the growing increase in financial wealth that the individual savers experience over time.
Thus it is wrong to think of consumers as either spending or not spending. The issue is, on what will they spend? If people stop buying Coke and switch to Pepsi, that certainly doesn’t spell disaster for the economy as a whole. No, it just means that Coke fires workers and Pepsi hires workers. So by the same token, if people stop buying present consumption goods and instead “buy” items such as a future college education or even just a bigger estate to pass on to their heirs or charitable foundations, it won’t disrupt the economy as a whole. It will simply reallocate workers and other resources to cater to the new preferences.
The Harmful National Income Statistics
As the absurd quotation above illustrates, these elementary fallacies are largely due to the focus on aggregate figures such as Gross National Product (GNP), or the now fashionable Gross Domestic Product (GDP). (The distinction is between what US citizens produce, versus what is produced within the United States.)
It is a simple fact of accounting that the total monetary value of goods and services produced within a year will equal the total money spent on those items. Fair enough. So if we disregard the numerous methodological pitfalls involved and suppose we can measure GDP from the production side, we can just as well come up with the same number by adding consumer and government expenditures, net investment, and net exports. (Many readers are no doubt familiar with the nauseating equation, GDP = C + I + G + NX.)
Unfortunately, many people, including trained economists, leap from this truism to the completely unwarranted belief that an increase in one of the components on the right hand side will cause total production to go up. To see how dumb this is, consider your own personal budget for the month.
Suppose you make $5,000 per month, and your expenses are $2,000 on the mortgage and utilities, $500 on your car, $1,500 on food, clothes, and entertainment, $500 on savings, and finally $500 to repair a leaky roof. If you used an Excel spreadsheet these cells would all tie together nicely. Now imagine some hooligan kids rip up your roof halfway through the month, forcing you to spend yet another $500 on it. Could they point to your formula in cell D35, and explain that your monthly income should now go up to $5,500?
The Sovereign vs. the Idiot
Important as my tirade is, it’s getting away from the real point of the Slate article. What the author really wants to discuss is whether it is “efficient” to give presents, rather than allowing individuals to make their own purchases.1 To that end, he conducted numerous surveys and asked people to guess how much others spent on presents, versus how much the recipients would have to be paid to give up the gift. The idea is to compare the price of the gift with its value to the recipient. The author concludes:
Here’s what I’ve found. On average, a dollar that people spend for themselves creates nearly 20 percent more satisfaction than a dollar that someone else spends on them. Put another — depressing — way, gift-giving effectively discards 20 percent of the gift’s price. So, of the nearly $100 billion spent on holiday gifts each year, one-fifth is effectively flushed down the toilet.
There are so many problems with this it’s hard to know where to begin. First, one can’t measure “satisfaction.” Austrian economists are the most adamant in stressing the ordinal nature of preferences. You can certainly rankdifferent items in terms of their utility, but that doesn’t mean you can assign a cardinal number of “utils” to each. For an analogy, it is perfectly fine to rank people from your best friend down to a mild acquaintance. That doesn’t mean that really your best friend has the most friendship units, followed by 2% fewer friendship units in your second best friend, and so on down the ranking.
Another problem is that the author here never steps back and asks the students if they would like to abolish the practice of gift-giving altogether. After all, if 20 percent of the value is flushed down the toilet, wouldn’t we all be better off if we only bought things for ourselves? Yes, we’d miss out on incoming gifts during the holidays, but by the same token we wouldn’t have to buy gifts for others. We’d also avoid the hassle of returning ridiculous items and having to make excuses when your in-laws ask why you never wear that orange sweater.
Although we can all laugh at some of the absurdities involved, and everyone knows about the proverbial fruitcake, even so most people enjoy the holiday season. They like shopping for their friends and family. They eagerly anticipate what they’ll find under the tree. These are all real benefits of the tradition, yet the author’s survey misses such things entirely.
It’s rather ironic when you think about it. In other contexts, the free market is criticized for its atomistic decision making. There could be a “Pareto improvement” if people could put aside their narrow self-interest and act out of altruism. And now, here we have a critic lamenting that free individuals are “inefficiently” neglecting the personal gains from selfish spending.
The Misesian View of Consumer Sovereignty
To his credit, the author doesn’t call for government action. Even so, there is no doubt that he faults the market. Consider his final passage:
So two cheers for the sovereign consumer. As dumb as people may be, they are still better than others at choosing their own shirts and CDs and perfume. And forget about government as the sole bogeyman of inefficient allocation. Your Aunt Sally is at least as bad as your Uncle Sam.
Of course, we can understand that some of this sentiment is simply because the author wanted to end with an ironic quip. Even so, it is inexcusable to leave out the slight little fact that Aunt Sally is “inefficient” with her own money, while Uncle Sam steals his at gunpoint. That’s why we obstinate ideologues tend to focus on the “sole bogeyman” of the taxman.
In closing, let me urge those who wish to see an entirely different take on the sovereign consumer explore the writings of Mises. This great economist explains that, although entrepreneurs steer the ship of the economy, they ultimately take their orders from the consumers. It has nothing to do with our personal judgments as to whether the consumers’ orders are “rational” or not, but rather is a simple statement of fact.
Investors and entrepreneurs are the driving force of the economy, as noted above. Without their saving and efforts, there would be no production. But it is ultimately consumer preferences that determine whether the production efforts were a success or failure.
The free market is a flexible nexus of sovereign individuals, in the sense that everyone has a well-defined set of property rights that others must respect. Yet in this arena, there is plenty of room for altruistic traditions such as holiday gift-giving. It is only a narrow, mechanistic branch of economics that has difficulty with such nuances. The Austrian School, in contrast, can easily handle the real world in its analyses.