Tuesday, January 3, 2012

Consumer Spending Does Not Create Jobs

In 2007, before the recession started, combined personal and government consumption expenditures were $11,697,000,000. By the end of 2010, they'd risen to $11,777,000,000 (both figures are in 2005 dollars). Now, the Keynesians tell us that recessions are caused by a drop in consumer spending and can be ended by government's spending money to make up for the shortfall of the newly-stingy consumers. But here we are -- spending has returned to and exceeded pre-recession levels yet employment is at its lowest level in three decades. How can this be?

The answer, little understood at the time and almost completely ignored now, was clearly laid out over a century ago by John Stuart Mill.

We pass now to a fourth fundamental theorem respecting Capital, which is, perhaps, oftener overlooked or misconceived than even any of the foregoing. What supports and employs productive labor, is the capital expended in setting it to work, and not the demand of purchasers for the produce of the labour when completed. Demand for commodities is not demand for labour. The demand for commodities determines in what particular branch of production the labour and capital shall be employed; it determines the direction of the labour; but not the more or less of the labour itself, or of the maintenance or payment of the labour. These depend on the amount of the capital, or other funds directly devoted to the sustenance and remuneration of labour. . . .

This theorem, that to purchase produce is not to employ labour; that the demand for labour is constituted by the wages which precede the production, and not by the demand which may exist for the commodities resulting from the production; is a proposition which greatly needs all the illustration it can receive. It is, to common apprehension, a paradox; and even among political economists of reputation, I can hardly point to any, except Mr. Ricardo and M. Say, who have kept it constantly and steadily in view. Almost all others occasionally express themselves as if a person who buys commodities, the produce of labour, was an employer of labour, and created a demand for it as really, and in the same sense, as if he had bought the labour itself directly, by the payment of wages. It is no wonder that political economy advances slowly, when such a question as this still remains open at its very threshold. I apprehend, that if by demand for labour be meant the demand by which wages are raised, or the number of labourers in employment increased, demand for commodities does not constitute demand for labour. I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes; and that it is only by what he abstains from consuming, and expends in direct payments to labourers in exchange for labour, that he benefits the labouring classes, or adds any thing to the amount of their employment.

-- John Stuart Mill, Principles of Political Economy

When I buy, say, a new snow shovel (we had a foot of lake effect snow here yesterday and today, so shoveling is on my mind), I buy only a shovel. I do not also purchase the steel that went into the blade, the wood in the handle, or the work that went into its creation. Just a shovel.

The raw materials and the labor involved in the manufacture of the shovel were paid for out of the capital of an entrepreneur months or even years before I even thought about needing one. He was required to save or to borrow someone else's capital to fund his operations because none of his suppliers or his employees would have consented to waiting for their payments and wages until Craig went out and bought a shovel some months in the future. The purchase of consumer goods and the creation and deployment of capital are entirely separate transactions.

As George Reisman wrote in Capitalism:

If it really is the consumers rather than businessmen who pay for factors of production, then why can't a prospective entrant into any line of business simply tell the workers he wants to hire and his prospective suppliers that they will be paid by the consumers of the products he will ultimately make possible, and thus should not bother him with their claims?

Capital formation is the result of saving, not spending. Entrepreneurs withhold a portion of their revenues from their own consumption to fund future operations and potential expansion based on their own assessments of the future market and profitability of the products they produce. The owner of the shovel plant may, for example, be a believer in global warming alarmism and make the decision that there is no future in the production of snow shovels. Therefore, he takes the proceeds of his shovel sales and retire to Churchilll Bay. Ultimately, my purchase had no bearing on his determination.

All of which explains why the government's extraordinary spending spree has not increased employment but has actually driven the labor force participation rate down. No amount of spending on goods will create a single job. If the Keynesians want to create jobs through government spending, they'll have to take Mr. Mill's advice and hire them themselves.

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