Monday, December 29, 2008

Do High Income Individuals Have a Lower Marginal Propensity to Consume or a Higher Propensity to Import?

Kevin Drum seems to believe the former:

One way or another, there's really no way for the economy to grow strongly and consistently unless middle-class consumers spend more, and they can't spend more unless they make more … The only sustainable source of consistent growth is rising median wages. The rich just don't spend enough all by themselves.

Kevin seems to be arguing that as income distribution gets more tilted from the poor and middle class towards the rich, consumption as a share of national income will fall. OK, we are currently concerned about an insufficiency of aggregate demand given that the sum of net investment and net exports is barely above zero. During the transitional (perhaps defined as a couple of years) Keynesian period of weak investment demand, we have the paradox of thrift where any upwards shift of the national savings schedule will only deepen the recession.

But even the most die-hard Keynesians accept the Solow proposition that in the long-run, any increase in national savings will encourage more investment. And if Kevin is right about the rich having a lower propensity to consume – that is, a higher propensity to save – the old trickle down nonsense about taking from the poor to give to the rich would at least spur more investment demand and long-term growth.

Paul Krugman, however, isn’t buying this assumption:

There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do. In fact, the prosperity of New York City in the last decade — largely supported off of super-salaried Wall Street types — is a demonstration that you can have an economy sustained by the big spending of the few rather than the modest spending of large numbers of people.

I’m not sure I’m buying this notion that distributing income from the rich to the poor is going to necessarily reduce our national savings rate either. But here’s a related query related to the Keynesian multiplier related to certain open economy musings by Dani Rodrik:

It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care? Being the open economy that it is, I fear that the U.S. will have to confront this dilemma sooner or later. In an environment where the dollar has already appreciated against the Euro and even more significantly against emerging market currencies, fiscal stimulus here will produce an even larger current account deficit. If American consumers decide to spend 40 cents of a dollar of additional income on cheap imports from China and other foreign countries, the multiplier will be a mere 1.3. How long will it take before politicians of all stripes cry foul over the leakage through the trade account and the "gift to foreigners" that this represents? And they will have Keynesian logic on their side.

Let’s postulate for a moment that the rich have a high marginal propensity to consume imported goods than do the poor. Even if redistributing income from the rich to the poor does not increase overall consumption (that is, we as a nation still save the same amount), it might induce less imports and more domestic spending.


BruceMcF said...

"But even the most die-hard Keynesians accept the Solow proposition that in the long-run, any increase in national savings will encourage more investment."

No, one key point that distinguishes actual Keynesians from faux-Keynesians of various vintages is understanding that an increase in national "saving" only enables more investment under conditions approaching full employments ... which we most definitely have not been operating under during the decade to date.

Obviously more national investment will lead, pari passu to more more saving, since with an increase in injections into the income-expenditure model, incomes will rise until leakages have been brought into equality with injections.

To agree with Solow's proposition requires either imputing to the economy a tendency to full employment that has not been shown to exist, or some other flawed conception of the economy, such as the loanable funds fallacy or the neoclassical model of interest rate determination.

Anonymous said...

Investment? If, for some reason, we have a shortage of excess capacity, just lay off another million workers. We can get more unused capacity without investing a dime. It's been working so far...

TheTrucker said...

For me it is not really a question about the marginal propensity to spend or save. We have had about 28 years of trickle down stupidity and we now "have a nation of drive through banks and hamburger stands".

Investment has "leaked out to the east" and it continues to do so. What we have here in America is "investment" in bonds and T-Bills as the government fails to tax appropriately and just borrows, and borrows, and then borrows some more. When the return to zero risk bonds is positive you can expect a very bad _REAL_ economy.

Import tariffs are necessary to stop the offshoring of all the manufacturing and, in truth, everything else. The Rich get much more powerful by NOT INVESTING in America thus creating a very hungry and pliable lower class.

Wealth (in societal/political terms) is the capacity to forgo labor or to command the labor of others. The notion of "wealthy" is, in fact this ability to command the labor of others. And the more of them there are, the easier it is.

Eleanor said...

New York is an international market, where the world's rich spend money. A lot of American cities do not prosper off the spending of the rich, because their rich are spending money in New York, not locally.

Do you get less saving if you distribute money down?

(a) Maybe not, because you'd have many people saving a little, rather than a few people saving a lot. If the poor many can save as much as the rich few, then there is a no reason to have the rich, since their social purpose is to save and invest. (I can't think of any other reason for them. The consumption of luxury goods seems like an inadequate justification. When I look at them, I see little except huge waste in a world that can no longer afford waste.)

(b) If savings are being invested in bubbles rather than productively, it seems to me they become dangerous rather than useful. Maybe spending money on goods, which might encourage the production of more goods, is a better idea.

(c) As Brenda points out, we are reaching the limits of growth. So the whole question of how we spend money and care for people and the planet is open to question. Can we continue the old process of saving and investment and production endlessly? No. What comes next?

Anonymous said...

Are we going through this debate again. I thought it had ended fifty years ago.

1) The rich spend less than the poor. Poor people live hand to mouth. They spend every penny they get. If the rich spend more, then they have to spend more than they get. After spending like this for a while they will no longer be rich.

2) Successful investors are not stupid. There is no point in investing in productive capacity if there is no market for the relevant goods or services. A market consists of people with needs, desires and money. Investment lags rising incomes. We haven't been seeing much in the way of rising incomes, so this fact is not in currency.

3) You can have a trickle down society, but it eventually stagnates since the money WILL concentrate on the top. Poor people circulate money, rich people accumulate it and take it out of circulation. You can prevent this stagnation by forcing the circulation of the money by taxation or by conquest, that is, taxing the conquered.

The theory is simple, and it has repeatedly been reinforced by the facts. My father was an old New Dealer who came of age on the NYSE in the 1930s. I've followed his investment strategy using old fashioned New Deal type economic analysis. It may be unfashionable, but it pays the rent and for the occasional bottle of Krug.

Anonymous said...

One issue which The Trucker alludes to is that the Rich have a propensity to invest abroad. In the long run this may not matter (that's a discussion for another day) but in the short run, even if they are getting 10% interest, they are effectively removing 90% of the investment from circulation within the home country (USA in this case) for a year.

Unknown said...

"Let’s postulate for a moment that the rich have a high marginal propensity to consume imported goods than do the poor."

It would be interesting to investigate this channel by modeling it in a theoretical setting. However, is there any empirical evidence supporting this conjecture?