'For increased consumer spending to be sustainable, there must
'For increased consumer spending to be sustainable, there must
be employment growth as well as higher labor productivity.'
;JP;
ANPAk..r..
Lingle-consumption-growth
JP/6/
CONSUMPTION IS NOT THE SPARK BEHIND ECONOMIC GROWTH
Christopher Lingle,
Bali
Indonesia's economic growth exceeded 5 percent in the third
quarter of this year, up from a revised 4.54 percent in the
previous quarter. Many commentators have suggested that a
consumption boom was behind much of this news. For its part,
consumption grew by 5.1 percent in the third quarter.
It is often pointed out that private household consumption
contributes almost 80 percent of GDP. And so it is understandable
that it is so often mistakenly depicted as a primary driver
behind Indonesia's economic growth.
It is a mistake to consider the increase in personal
consumption as being behind the real growth in GDP in Indonesia
or any other country. It is the economy that keeps the consumer
afloat and not the reverse.
This is not an unanswerable argument like the chicken-or-egg
issue. There is strong theoretical backing and ample historical
evidence to make a decisive stand. Paraphrasing an economic law
named after 19th Century French economist, Jean-Baptiste Say,
market economies work on the basis of the supply of one good
creating the demand for one or more other goods. In other words,
you must first produce to be able to consume.
And so it is that the appropriate direction of causation is
that production creates the basis of purchasing power that allows
consumption to take place. Evidence of this is seen in that those
countries with high levels of consumption are those with the
highest levels of production.
Another reality check relates to whether more new jobs are
being created. For increased consumer spending to be sustainable,
there must be employment growth as well as higher labor
productivity. It turns out that household spending, job growth
and rising productivity depend upon increased business
investment.
At the same time, simple logic reveals that increasing current
consumption means less is saved so fewer resources are available
for investments that allow future consumption. And the reduced
investment causes the production structure to contract so that
future living standards are lower than they would have been.
In all events, the theoretical approach to national income
accounting is deeply flawed.
This causes the estimates of GDP to greatly understate
business spending and grossly over-exaggerate consumer spending
as a proportion of total economic activity.
When calculations of total business expenditures take into
account spending between stages of production, it is considerably
higher than consumer spending. However, most business spending is
left out of GDP calculations because this supposedly would
involve double counting.
To reiterate, growth is driven by capital accumulation, not
consumption. As more capital is accumulated, more can be produced
so that more can eventually be consumed.
And it is increased productivity from capital accumulation
that brings higher living standards. Increased material means of
production provide the basis for more real savings so that when
accompanied by technological change and entrepreneurs willing to
take risks, there can persistent increases in economic growth.
Neither deficit spending nor low interest rate can change the
real fundamentals of an economy. Politicians might believe that
stimulating the economy is a good idea since it can win votes.
But economists should know better that short-run economic
stimulus is misguided and leads to long-run losses.
One way to change economic fundamentals and encourage a
sustained recovery is permanent reductions in marginal tax rates
and the reduction or elimination of capital gains taxes. Capital
gains taxes and high marginal tax rates do not punish the
wealthy. It is those who seek to increase their wealth that bear
the heaviest burden.
The misguided conventional wisdom about the role of
consumption and aggregate demand in an economy must be abandoned.
Those believing consumption and demand are essential to economic
growth must accept that government spending on armaments and
weaponry is good for an economy. Perhaps they also believe in the
tooth fairy?
But neither war nor terrorist acts are beneficial to overall
economic growth. Were it otherwise, the rebuilding after natural
disasters like hurricanes and floods would make them welcome
events.
A more important indicator of sustainable future growth is
higher business investment and capital formation. And so it is
encouraging that domestic investment rose as indicated by the
rise in gross fixed capital formation by 13.1 percent year-on-
year in the third quarter.
Unfortunately, the World Bank has pointed out that Indonesia's
rampant corruption, legal uncertainties and threat of terrorism
create a hostile climate for investors. These conditions inhibit
both foreign direct investment (FDI) inflows as well as domestic
investment.
For Indonesia to enjoy sustained economic growth, there must
be a greater focus upon encouraging fixed capital formation.
The writer is Professor of Economics at Universidad Francisco
Marroqumn in Guatemala and Global Strategist for eConoLytics.com.
He can be reached at clingle@ufm.edu.gt