European economies are in grave trouble, as everyone knows, beset by high inflation, impossible regulations, legacy corporate cartels, and a vast welfare state. The solution is always and everywhere thrift, cut the budgets, sound money, and a free market. That should be obvious, but it is not, for whatever reason.
Reporters on this topic keep making a mess of things. These are people with a smattering of economics knowledge; they vaguely remember from a 101 class many years ago and then make it up from there.
Somehow, in the course of this improvisation, reporters are reinventing the fallacies of John Maynard Keynes, even his most crude analytics. Consider this report I just read from a mainstream source:
“Europeans have doubled down on frugality in recent years—another economic headache for the continent. Consumers’ reluctance to spend is a key reason why Europe has lagged behind the U.S., where robust spending especially among higher-earners has driven growth.
“Longstanding societal norms of thrift and modesty, and lingering memories of wartime scarcity and inflation, have helped make saving an obsession and moral imperative.”
You might think this is a good thing. Better that income exceeds expenditures. That’s just accounting. Overspending is the path to insolvency. It certainly is good for the household. But in Keynesian-style thinking, what’s good for the household is bad for the macroeconomy. Hence the supposed paradox. If you do what is good for you, you harm others. By doing what’s bad for you, you help others.
This is not exactly how Keynes put it, even if that is the upshot. You can see the germs of his theory here from 1936:
“For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself. It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment.”
I quote that not in the hope that you can follow his thinking because, actually, it makes no sense. Or rather, it kind of does once you change the traditional definitions of words and causal relationships.
Keynes was clearer here:
“There are today many wellwishers of their country who believe that the most useful thing which they and their neighbours can do to mend the situation is to save more than usual. ... It is utterly harmful and misguided—the very opposite of the truth.”
OK, there we go. Stop saving and start spending. That’s how you make a contribution to the national well-being. So said Keynes.
In truth, if you follow that advice, you end up in bankruptcy. You are the egg that makes the omelette. Contrary to Keynes’s prediction, the same is true for whole nations, even if profligacy can generate the appearance of prosperity in the short term.
This whole theory was the basis of the New Deal, which prolonged that economic calamity for a decade. Government policy tried to stop prices from falling and then tried to prod people into spending more money, which they did not have. Government would help by spending as much as possible, an idea that politicians just adore.
This was based on the theory that the downturn was due to a failure of aggregate demand when it was really a consequence of a mismatch between production and consumption, due to monetary expansion of the previous decade.
What the economy needed was a reset: new prices, new business, bankruptcies of unsustainable products, and more savings. The saving happened in any case and provided the basis of the enormous postwar recovery. It’s a good thing that the Keynesians did not get away with the scam. But they did cause enormous damage along the way.
Among the damage was a habit of government to spend more than it has, running deficits and debts. The problem started small by today’s standards, but it grew worse over the decades. Frugality in government then became a thing of the past, as economic growth slowed over time, simply because government debt crowds out private investment.
In other words, events proved that Keynes was entirely wrong that societies can spend their way out of recessions. Indeed, that habit has the opposite effect—for households and whole economies.
For some reason, economic lessons do not stick well. Whenever there is an economic downturn, the cry goes out to spend more money when you should be doing the opposite. That’s what’s happening in Europe today, as governments and the media are blaming regular people for not spending enough and hence driving down market demand.
It’s like simple math evades these people’s understanding. The end point of saving is investment, which is the basis of real production and output growth. Saved funds become borrowed funds and a stock of capital for matching production and consumption. There is no substitute for that. Certainly, central bank financing doesn’t work as a proxy, as a kind of fake and forced savings to stand in for the real thing.
Europe is filled with zombie corporations and governments, in part a result of a push against thrift.
In fairness to Keynes, the idea that an economy is driven forward by consumption rather than production was not new. He took this idea from writings already in circulation going back decades.
It’s a strange theory because it turns the entire economic problem on its head. The issue is never inspiring people to buy more. We live in a world of unlimited wants. It’s the means of meeting them that are limited, and therein lies the core problem that economics seeks to solve.
Adam Smith sought to explain the wealth of nations, not the consumption of nations. It’s the production of wealth that is always and everywhere at issue.
Europe cannot reenergize output with more debt and less frugality. That is the path toward further ruin. In contrast, we have a long historical record of high-saving societies generating massive increases in output. This is for a simple reason. High saving equals low interest rates and sustainable investment, because the math checks out in a world of unlimited wants and limited means.
There is no magic solution to low growth that can be generated by overconsumption and debt. The long-term solution for households is the same for nations. Live within your means, store up resources for the future, and don’t try to game the system with easy money and debt. Most nations of the world have abandoned this time-tested wisdom, but that makes it no less true.
