What Happens in a Bad Economy?

Politicians like to talk in abstractions.

Come to think of it, they like to argue and obfuscate in abstractions, as well. They campaign in abstractions and make abstract pledges until those abstractions turn into something tangible, like a subprime lending crisis or a downgrade from a particular private rating agency.

We spend so much time wading through abstractions that we cannot get to the meat of the issues that face us today. Enough of that.

What really happens in a bad economy? And what is the public's role during these tough times?

Americans feeling the pinch have less disposable income–their paychecks go in increasing amounts to paying the bills and saving to make ends meet.

This means there is less overall consumer spending. Sure, certain industries do better–oil & gas, for instance–because they are pseudo-required for transportation to and from work or school.

Less consumer spending means lower demand for durable goods (automobiles, clothes, household appliances, etc.). This lower demand results in lower prices for these goods (or even a forced lower supply).

Lower prices & lower supply means businesses bring in less money and potentially less profit. This means big-time layoffs and a plethora of pink sheets.

Fewer workers and fewer wage jobs further decreases consumer spending, even though prices have lowered. This drives that vicious circle even farther, resulting in even greater job loss.

All of this illustrates what we can call the “paradox of thrift:”

“By attempting to increase its rate of saving, society may create conditions under which the amount it can actually save is reduced. This phenomenon is called the paradox of thrift….[T]hrift, which has always been held in high esteem in our economy, now becomes something of a social vice.”

Pundits are fond of saying that “if a family operated its finances like the federal government, they would go bankrupt!” This is true, from the whole to the individual unit in society. But the revered Adam Smith wrote, “What is prudence in the conduct of every private family can scarce be folly in that of a great Kingdom.” The implication that spending in the federal government is wrong or evil is false; it's a “fallacy of composition.”

What does that mean? “If a population saves more money…then total revenues for companies will decline. This decrease in economic growth means fewer salary increases and perhaps downsizing. Eventually the population's total savings will have remained the same or even declined because of lower incomes and a weaker economy.”

So what is the role of the public–through their government–in these tough economic times?

Government spending bridges the gap–while the overall propensity of families across the nation may be to save, public investment slows the contraction of the economy due to that subsequent lower demand we talked about earlier. Government spending helps individual families do what is economically prudent according to their own circumstances, without unnecessarily dragging down the national economy.

In other words, when you and your family are focused on spending, you can't help grow the economy through your usual spending and investment. That's where public investment is pivotal–and has historically brought us through rough patches.

Of course, this argument presupposes that in good economic times, government–as a matter of course–spends less; this did not happen from 2001-2008. Unnecessary government spending on programs with no long-term benefit to the American public–the Bush-era tax cuts and spending on two major wars–drive up both deficits and explode the national debt. That is what has driven the current debt/deficit reality.

(And for those worried about raising taxes on families in tough times–I certainly am–let's simply let the Bush tax cuts expire already. They cost the country a whopping $1.8 trillion, contributed to the housing bubble and did not achieve growth. They did the exact opposite of what a responsible government does when the economy is strong; instead of running a surplus and paying down the debt, they ran up needless deficits and exploded the national debt.)

(Cross-posted from The Journeying Progressive.)

About the Author(s)

The Journeying Progressive