Earn What You Spend

A mere six months ago, the phrase the ‘Paradox of Thrift’ was unknown to virtually everyone besides dedicated economists and academics.  It has now spread into our common parlance - it’s hard to pick up a newspaper these days without seeing at least one reference to this economic theory.

The reason behind its emergence is simple: it succinctly explains our current economic situation as well any other theory.  While there are certainly many facets to our current situation whose explanation is more complicated, the Paradox of Thrift explains a significant portion of our recession quite well.  Consumers were overspending, so they had to pull back.  Yet when everyone pulls back at the same time, our GDP contracts.  What’s good for the individual becomes problematic for the aggregate. 

So just what is a patriotic saver to do?  According to David Leonhardt, the President himself ducked the question of whether we should spend or save any potential rebate from the stimulus package.  Fortunately, he (Leonhardt, that is, not Obama) did come up with an effective list of ways to save while stimulating the economy.  The crux of these prescriptions is in spending money as an investment, rather than for the sake of consumption.  Investing still requires an expenditure - which is a net positive for the economy - but you expect a return (which can take the form of future savings) - which is a net positive for you, the individual.  It is, as they say, win-win. 

A few of my favorite ideas from Mr. Leonhardt: 

• Parents of young children can join Costco and make up their membership fee with just a few months of diaper purchases.
• Drivers can inflate their tires, change their air and fuel filters and start getting better mileage.
• Purified water drinkers can lay off the Aquafina and buy a water filter. Seltzer drinkers can buy a seltzer maker. 

Spending as an investment is critically important for businesses and governments, not just consumers.  It’s the origin of the claim that you are throwing away money if you rent instead of own real estate (though this is not always true).  Any expenditure in this massive stimulus package we are about to pass needs to not just spend money in the short term, it needs to be an investment for the long-term.  It’s only then we get the immediate stimulative effect of the expenditure and the future dividends from the investment.