Consumption Shares, Inequality, and Growth

January 10th, 2013 at 7:25 pm

In work I’m doing for a paper on the relationship between inequality and growth, I was reminded about an underappreciated difference between our economy and those of other advanced economies: we consume a considerably larger share of our output than they do.

I’ll get to why this matters in a moment, but the evidence is in the figure below, from the OECD.  The US share is about 72%; the average without the US is about 55% (there are two outliers—Greece on the high end and Luxembourg on the low end—exclude them and you’re still at 55%).  That’s a big difference.

There are lots of reasons for these differences, many of which go beyond economics and into culture.  Roughly speaking, when output per hour (productivity) grows, you can work more and buy more, or work less without being worse off.  We tend towards the former; many of these other countries tend toward the latter.

But is there anything here that bears on inequality and growth?  Well, maybe it’s this: in a country that has both a high consumption share and very high inequality, you might worry more about different propensities to consume across the income scale and their impact on growth.  That is, since middle and lower income people are more likely to consume (vs. save) their marginal dollar, when high inequality diverts growth largely to the top of the pay scale, that should hurt growth here more than in countries whose GDP depends less on consumer spending.

It’s a testable hypothesis which maybe I’ll test unless one of you beats me to it!

Source: OECD

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4 comments in reply to "Consumption Shares, Inequality, and Growth"

  1. Bill Gatliff says:

    Speculating, and likely butchering the language and concepts of a field I know very little about. But I’ve never let that stop me before! :-)

    Market segments with a lot of “churn” and sales transactions, like groceries, don’t need a lot of profit per transaction in order to make money for the producers. They just need unit sales volume. (I know I’m oversimplifying here, work with me a sec.)

    Bump up the sales volume by making credit more available, and you increase profits even further (assuming there aren’t other factors preventing purchases e.g. “I don’t need diapers, because I don’t have a baby in the house”). At some point, a producer starts increasing prices because (a) they need to throttle demand, or (b) the reduced sales volume gets offset by higher profit per unit sale. They make the same money, but with less work.

    So prices go up, but nobody cares for awhile because they have credit. And they go get more credit (two jobs, etc. ) as prices go even higher.

    The whole time, however, the vendors are converting that credit back into cash at their end. In other words, each credit-based purchase is pushing cash “uphill” into producer’s pockets. And that cash stays around even as purchasers exhaust their credit and enter bankruptcy. A kind of “ratchet” effect.

    So I can see that consumption inevitably leads to inequality unless there’s something else to push some of that money back “downhill” e.g. taxes. Simple market pressure doesn’t seem enough, because (a) no successful businessperson risks a “race to the bottom” by under-pricing their competitors, and (b) unless companies are giving actual cash to their customers, lower prices are at best just slowing the uphill cash climb.


  2. Nhon Tran says:

    Thank you. In my view, consumption does not drive economic growth. It’s investment in infrastructure and plants and machines and technologies that drives ongoing growth. Who has a higher propensity to invest in these categories of spending?
    Regards.


  3. Kevin Rica says:

    Our savings come from abroad. We have a huge inflow under capital account because we are a reserve issuer. When China, Singapore etc need to fix their exchange rates and buy reserves, savings flow into the American economy.

    This results in a higher proportion of consumption here and lower savings. If (and when) we do not compensate by reducing our own savings — S > I and we have a classic recession due to inadequate aggregate demand.

    If we want to reverse this — we have to end the American role as reserve issuer.


  4. Jim Carey says:

    I believe it was in “I’ll be Short” by Robert Reich that he posited that the propensity for Americans to work harder for more consumption (vs. working less for the same level of lifestyle) was due to economic conditions. As I recall, his thesis was that the alternative to working harder didn’t appear to be stagnation, but looked more like a high liklihood of falling off a cliff wage wise and that (of course) wage earners were opting to work even harder rather than take that chance. Do you think there are policy considerations that could improve our ability to “work less for the same lifestyle”?


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