Tuesday, February 19, 2008

Stimulus and Wealth/Income/Consumption Gap

In a recent meeting, a colleague commented on the recent information about the differences in income and consumption among those at the top of the distribution and those at the bottom. The specific observation was that it seemed to indicate that "trickle down doesn't work" or something to that effect. While I didn't respond directly to that comment, I did say something about what isn't spent is usually invested; but not wanting to get into a political discussion, I didn't pursue it. (I generally avoid political discussions because I don't trust politicians of any persuasion. The cynic in me believes that their interest in the position automatically makes them suspect. But that's a subject for another post.)

However, the comment did cause me to continue thinking. As I look at the information, I'm having a hard time seeing where the "trickle down doesn't work" is coming from. From the data, those in the highest income segment spend more than those who don't. What was probably meant was that those at the high end don't spend as great a part of each dollar as those who at the low end. I would agree with that. But I would also point out that because Y = C + S (or income equals consumption plus saving), the funds are still put to use, just differently.

It seems logical that those in higher incomes don't spend all their money on consumption. But it's also fair to believe they don't hide it in a box in the back yard, a mattress, or other non-return generating places. Money is a tool to be used. What is not consumed is usually invested, which provides capital for further production, which one hopes is consumed eventually. The question then becomes "does direct consumption or capital investment have a larger impact in the economy through improved output and productivity, and over how long a period of time?"

This then relates to the marginal propensity to consume of individuals or groups. In other words, do we know or can we predict what any group (I'll avoid individuals) will do with an additional dollar of income. That's where I think the debate inevitably bogs down because factions will promote their view of this marginal propensity: stating or misstating it to their advantage.

One group that feels any stimulus should be directed towards those at the bottom of the income distribution will hold that dollars spent here will have a greater likelihood of being spent on new consumption. This may or may not be true depending upon their existing debt situation and their perceived need to improve that.

Yet another group feels that stimulus should be directed towards those at the upper end of the income distribution because that group already pays the largest share of taxes, and that group will be able to use the funds for new spending. But the upper income group may also choose to reduce their debt position or may choose to invest the windfall, which will not have the immediate effect of consumption. Some of that will depend on how large the stimulus is, I suspect.

While the package has already passed, did you use the stimulus package to discuss marginal propensity to consume, and are you using the recent information on wealth/income/spending gaps to augment the discussion?

I look forward to your comments.


SamYoung said...

I know your question was aimed more at teachers, but as a student of econ. I have seen and heard much disscussion of the stimulus and all economic evidence seems to point to that no matter to whom you give it, it won't be more than marginally effective if at all.
In regard to what was said about the wealthy not hiding their money in a box, "What is not consumed is usually invested, which provides capital for later production." reminds me of a section I recently had to read for class in O'Rourke's "Eat the Rich". The point of the section was determining wealth and in the process de-glorifying communism, but I think the same reasoning can be applied here.
He talks about two kids who graduate, one chains himself to a tree and saves a tree and one becomes a investment banker and makes a lot of money. He then goes on to explain how even if the banker cheats the IRS, his money is still probably helping the economy more by being invested or spent and perhaps funding something greater, inadvertently... I don't explain it as well as he does. it's on p.244

Tim Schilling said...


While the original post was aimed at teachers, all commenters are welcome to throw in their views.

I'm glad you're learning to address the issues I brought up. The "economic way of thinking" will serve you well, I'm sure.

Thanks for reading the blog and for taking the time to comment.