Consumption not the spark behind economic growth<\/p>\n
Christopher Lingle, Bali<\/p>\n
Indonesia's economic growth exceeded 5 percent in the third
\nquarter of this year, up from a revised 4.54 percent in the
\nprevious quarter. Many commentators have suggested that a
\nconsumption boom was behind much of this news. For its part,
\nconsumption grew by 5.1 percent in the third quarter.<\/p>\n
It is often pointed out that private household consumption
\ncontributes almost 80 percent of GDP. And so it is understandable
\nthat it is so often mistakenly depicted as a primary driver
\nbehind Indonesia's economic growth.<\/p>\n
It is a mistake to consider the increase in personal
\nconsumption as being behind the real growth in GDP in Indonesia
\nor any other country. It is the economy that keeps the consumer
\nafloat and not the reverse.<\/p>\n
This is not an unanswerable argument like the chicken-or-egg
\nissue. There is strong theoretical backing and ample historical
\nevidence to make a decisive stand. Paraphrasing an economic law
\nnamed after 19th Century French economist, Jean-Baptiste Say,
\nmarket economies work on the basis of the supply of one good
\ncreating the demand for one or more other goods. In other words,
\nyou must first produce to be able to consume.<\/p>\n
And so it is that the appropriate direction of causation is
\nthat production creates the basis of purchasing power that allows
\nconsumption to take place. Evidence of this is seen in that those
\ncountries with high levels of consumption are those with the
\nhighest levels of production.<\/p>\n
Another reality check relates to whether more new jobs are
\nbeing created. For increased consumer spending to be sustainable,
\nthere must be employment growth as well as higher labor
\nproductivity. It turns out that household spending, job growth
\nand rising productivity depend upon increased business
\ninvestment.<\/p>\n
At the same time, simple logic reveals that increasing current
\nconsumption means less is saved so fewer resources are available
\nfor investments that allow future consumption. And the reduced
\ninvestment causes the production structure to contract so that
\nfuture living standards are lower than they would have been.<\/p>\n
In all events, the theoretical approach to national income
\naccounting is deeply flawed.<\/p>\n
This causes the estimates of GDP to greatly understate
\nbusiness spending and grossly over-exaggerate consumer spending
\nas a proportion of total economic activity.<\/p>\n
When calculations of total business expenditures take into
\naccount spending between stages of production, it is considerably
\nhigher than consumer spending. However, most business spending is
\nleft out of GDP calculations because this supposedly would
\ninvolve double counting.<\/p>\n
To reiterate, growth is driven by capital accumulation, not
\nconsumption. As more capital is accumulated, more can be produced
\nso that more can eventually be consumed.<\/p>\n
And it is increased productivity from capital accumulation
\nthat brings higher living standards. Increased material means of
\nproduction provide the basis for more real savings so that when
\naccompanied by technological change and entrepreneurs willing to
\ntake risks, there can persistent increases in economic growth.<\/p>\n
Neither deficit spending nor low interest rate can change the
\nreal fundamentals of an economy. Politicians might believe that
\nstimulating the economy is a good idea since it can win votes.
\nBut economists should know better that short-run economic
\nstimulus is misguided and leads to long-run losses.<\/p>\n
One way to change economic fundamentals and encourage a
\nsustained recovery is permanent reductions in marginal tax rates
\nand the reduction or elimination of capital gains taxes. Capital
\ngains taxes and high marginal tax rates do not punish the
\nwealthy. It is those who seek to increase their wealth that bear
\nthe heaviest burden.<\/p>\n
The misguided conventional wisdom about the role of
\nconsumption and aggregate demand in an economy must be abandoned.
\nThose believing consumption and demand are essential to economic
\ngrowth must accept that government spending on armaments and
\nweaponry is good for an economy. Perhaps they also believe in the
\ntooth fairy?<\/p>\n
But neither war nor terrorist acts are beneficial to overall
\neconomic growth. Were it otherwise, the rebuilding after natural
\ndisasters like hurricanes and floods would make them welcome
\nevents.<\/p>\n
A more important indicator of sustainable future growth is
\nhigher business investment and capital formation. And so it is
\nencouraging that domestic investment rose as indicated by the
\nrise in gross fixed capital formation by 13.1 percent year-on-
\nyear in the third quarter.<\/p>\n
Unfortunately, the World Bank has pointed out that Indonesia's
\nrampant corruption, legal uncertainties and threat of terrorism
\ncreate a hostile climate for investors. These conditions inhibit
\nboth foreign direct investment (FDI) inflows as well as domestic
\ninvestment.<\/p>\n
For Indonesia to enjoy sustained economic growth, there must
\nbe a greater focus upon encouraging fixed capital formation.<\/p>\n
The writer is Professor of Economics at Universidad Francisco
\nMarroqumn in Guatemala and Global Strategist for eConoLytics.com.
\nHe can be reached at clingle@ufm.edu.gt<\/p>",
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