Is spending the best option? (The 1st Fallacy of Economics)

Last time, I told you that spending is crucial for the economy. That is still true, but there is more. Remember, correctness/truth does not translate into completeness.

John Maynard Keynes invented the so-called "Paradox of thrift". The idea directly attached to the concept of "Circular Flow". Pretty much what he said is that being thrifty is good for yourself, but bad for the whole economy. The more you save, the less you spend, the less the economy earns. So he (or the other proponents of his theory) justified it by the following example that:

While broken window does not make you very thrilled, the money does not go to waste (no deadweight) because the repairman will get paid from you. Good for him, and this is how the economy runs.
Spending = Earning.

However! However, assuming that your window is NOT broken, you can instead save the money. Yes, being a little bit thrifty. You can turn the saving into a loan, or invest it to obtain return in the form of interest or capital gain. For instance, you can lend it to your friend at 10% interest rate (a nice return), or you can invest it in various ways such as in stocks and get, hopefully, 50% profit (an even nicer return). Of course, you also have the option to keep the saving in case of emergency, or you can use it to buy yourself a new iPhone!

So by not spending the money on repairing the broken window, you can use the money to generate return (loaning or investing), protect yourself against rainy days (keep saving), or buy stuffs (consuming). All the described options will help you somehow. The first 2 alternatives will most probably increase your future income (increase long-term income), making you richer. The 3rd option will alleviate the burden when, for example, your car broke. The 4th option is nothing but spending. Yes, the same spending, but this time, you spend for something you want/need and still pass the money along to the next person. Not just that, by spending for something you want/need, you will gain satisfaction, improved productivity, and so forth. For instance, buying a new car is not just about classiness, style, and luxury, but it also increases your standard of living and saves more gas! Not to say that the new window glass is not stylish, but wouldn't a brand new car be better?

So I guess spending is not always the best option. Well, it's good, but this is not a win-win strategy because you have to lose something so the others can get something. In contrast, the 4 other options as mentioned above seem to be much more efficient. It is a win-win strategy as the pie is expanded for everyone. You gain, they gain, the whole economy gains. This is much more sustainable in the long run.

In conclusion, spending is a must, but too much is inefficient. Yes, efficiency is important. By allocating your hard-earned $$$ bills (spend it efficiently and effectively) on something that increases your standard of living or resiliency/buoyancy in the future (long run), you are either directly or indirectly contributing to a sustainable economic development, a stable and manageable positive rate of growth that allows for a better welfare improvement.

so this is still rudimentary, just a slight glimpse into economics. It is an easy-to-understand concept, but it must never be underestimated as it is a building block into something bigger, better, much more intriguing, to which we are approaching.

Spending VS Earning

One of the earliest economic concepts I learnt is nothing other than this very idea that spending and earning are pretty much the same thing (i.e. spending = earning) when you look at the broad picture of the whole economy. To an individual, a spending is cash outflow, and an earning is cash inflow. So how can your spending be your earning? Well, that is not possible. But how about your spending = another's earning? Why not eh? Simply put, the $3.3 you spend on your daily Iced Latte at Brown (Brown is the best. True story.) will be credited to Brown's revenue. Let's just say your spending, no matter what you spend it on, is never a waste! Yes, there is always a recipient, and as long as that remains true, the whole economy will be healthy! (let's assume all else constant at this point).

So remember folks, spending may hurt you, but it helps the others because your expense is their income. And that is how GDP is measured. Just to remind you, when we look at the economy as a whole, expenditure is equal to income. So in measuring GDP of a country, to avoid double counting (adding both expenditure and income of the whole country together will severely distort the result by doubling the amount of the actual GDP), what they do is looking at either the income side or the expenditure side, NOT BOTH.

This is also what we call "Circular Flow", the very idea that gave rise to the world renown Keynesian economics. John Maynard Keynes, the father of the dubbed modern economics, was the one who was keen enough to notice that the decline in aggregate expenditure would severely hurt the economy because as expenditure plunges, income also falls (again, expenditure = income). During the great economic depression in the 1930s, Keynes urged the government to pump out spending (run deficit) so to keep the circular flow of wealth (spending -> income -> spending -> income...) going. This is called expansionary fiscal policy, in which the government will spend more or cut tax. As the government spent, the business world was able to rebound back on its feet, employment rose, and people were able to once again earn enough to spend to sustain their livelihood. So the little spending spark created by the government had made it possible to fix the stalled economic engine.

In a nutshell, spending is just as vital to the economy as earning. Even a broken window that forces you to call the glass repairman is not such a bad thing for the economy. I mean if everyone's windows are damage-proof, then we will lose a section of the job market (no window repairman since they have nothing to do!).

Of course, I am simplifying the concept as much as possible so that it is easy for you, the reader, to digest. Things aren't that simple. Theory is not perfect, and this one is no exception. There are loads of criticism deriding what I have just explained to you.

Next time, we will introduce an add-on to this topic. We will look at the forgotten side of the story by including new variables, make it a little bit more complicated for those seeking challenges.