Economics is a broad and vast field comprising intricate areas that would take years to master. This makes it very hard to summarise or reduce it to a simple point. However, if there was one simple lesson that I wished everyone knew about economics, one easy sentence or sound bite that could explain the essential core to people who know nothing else about economics, it would be: “My spending is your income”. This simple point, properly understood, explains everything you need to know about the important policy issues of the economy. It doesn’t explain everything, but it explains the important parts.
My Spending Is Your Income
What does the sentence mean and why is it important? Imagine you run a small shop, what is the one thing you want? Customers of course, to spend in your shop and buy goods. If people don’t spend then you will go bankrupt and lay off your staff. Hence your job and your income is dependent on the spending of others. If I go into your shop and spend my money, that keeps the shop going and pays the wages of the staff. But we are all employees somewhere, so I am in turn dependent on someone else spending money at my job. This means we are all interconnected and dependent on each other to spend money and buy each other’s goods.
This obvious point contains an important point. As we are all interdependent, if I decide to stop spending money and instead save it, that means some shop is going to suffer a decline in business. If it is steep enough, they may even have to lay some people off. Hence, what seems like being frugal and responsible on my behalf by saving money, if followed by enough people, hurts the overall economy and costs jobs. This is an example of when something makes sense on an individual level is inadvertently damaging on the national level (the economic term is “The Paradox of Thrift”). This is not to say that we should never save, but rather that excessive saving is damaging.
The important of this lesson is that it explains recessions and unemployment. If for some reason a group of people stop spending, the some businesses will suffer a decline in sales. If this decline is large enough then they will have to fire staff and may even close themselves. This has a knock on effect as these redundant workers now have less money and therefore spend less, thereby reducing someone else’s income. This means further business closures and further redundancies. Even those who are lucky enough to keep their jobs will probably face pay cuts. The economy slips into a downward spiral and the newspapers fill with stories of closures and layoffs. Now imagine you are a consumer in this economy (or just remember how it felt in 2009). You would be naturally very scared of having your pay cut or even losing your job. The natural response would be to cut back on spending and save as much as you can, in other words to batten down the hatches. However, if you remember the lesson, while this is sensible on an individual level, it only makes the national problem worse. It leads to more layoffs and actually increase the likelihood that you will have a pay cut. It is for this reason that cutbacks are self-defeating.
The lesson also explains what the solution to the crisis is. If the recession is caused by less spending causing lower income and uncertainty, then the solution is to boost spending and confidence. But who is to do the spending? It would be madness for a consumer to go on a spending spree, their income is limited and they are afraid of future cutbacks. Each individual is too small to have an effect on the economy, so no one will spend unless everyone else is spending too, with the result that no one spends. The economy would get a boost if businesses increased their spending, but what business is going to invest in this economic climate? Their sales are down already so it makes little sense for any individual to expand (this is the reverse of the problem above. What is illogical on an individual level makes sense on a national level). Therefore the only one left is the government. The government is the only body large enough that if it increased its spending it would have an impact on the economy. We must rely on it to pull the economy out of the recession, not for ideological reasons but simply because it is the only one that can. Furthermore if the government guarantees no further cutbacks and launches a program of large spending, then this will reduce the uncertainty in the economy. Consumers will no longer hoard money and delay expenses but will return to normal spending patterns. Businesses in turn will expand to meet this demand and thus boost the economy.
Now some might object to the government spending money as this will increase the national debt. But what is the point of the national debt if not something to be resorted to in times of emergency? Isn’t the point of borrowing to help us out of hard times? This is commonly practiced by consumers and businesses so why not the government too? Sure it will have to be paid back, but that is an action for the boom when the economy is doing well. In a recession, the government must spend or else the economy will stagnate (in which case the debt will never get paid back). When your car is caught in a ditch, your main concern is not using up too much fuel. Instead you have to (regardless of whether you want to or not or even if it was speeding that got you in the ditch in the first place) slam the accelerator to boost the car out of the ditch, whereupon you can return to focusing on fuel conservation.
Unemployment often seems like a mysterious force to ordinary people who cannot understand how people who want to work could possibly not find jobs. Where have all the jobs gone that makes them so difficult to find? The answer is lack of spending (or insufficient demand). Businesses hire people in order to make a good or perform a service. How many people they hire depends on how much sales they have or in other words, how great demand is. So if people do not spend enough, then businesses will not hire enough and unemployment results. The easiest way to think of it is to imagine that the economy requires a certain level of spending in order that all resources used and people employed. When the economy falls below that level, unemployment results, while if we go above it (which is very rare) inflation results. The role of the government is to adjust the economy so that we get as close to this level as possible. This is done by spending to reduce unemployment or cutting to reduce inflation.
This simple maxim, “My spending is your income” clearly explains the recession and the why the government policy of austerity is failing. Cutting spending only reduces income further and is the reason that after five years of cutbacks and austerity, Ireland is still mired in recession with only a slight improvement in the public finances. Every time the government cuts the wages of public servants, they spend less meaning businesses suffer and have to cut wages and lay people off. The government is actually making the problem worse! Austerity only pushes the economy lower and further reduces people’s income. As people have less money they pay less income tax, as they spend less they pay less VAT and as more are now unemployed, they cost the government more in social welfare. So not only is the economy worse off, but the cutbacks don’t even save any money.
The lesson applies to many public policy issues such as the minimum wage and trade unions. Traditionally people assume that higher wages cause unemployment, but this is only because they view wages solely as an expense. If wages are spent, then they are not an expense but someone’s income. So a higher minimum wage leads to increased expense but also increased sales. This simple lesson turns policy debates on their heads and should allow you to rethink the way we view government. In fact, in this light government spending should not be solely viewed as a burden on people but also as a source of income. So the next time someone boasts about how much can be “saved” by cutting government spending, remember that less spending means less income and net savings will be far less than the headline figure. This can be applied to all areas of government spending such proposals to cut social welfare, pensions, raise student fees, introduce a property tax, water charges or any form of tax hike or cutback. They all suffer from the same fault that they will leave less money in people’s pockets which will only make the recession worse.
My Spending Is Your Income
If there is one lesson I want to impart to everyone so that they can best understand the economy it is that “My spending is your income”. There should be monuments built with this slogan, it should be hoisted onto walls and tattooed onto economists. The solution to the recession is not further cutbacks because that will cause me to spend less and therefore reduce your income. Cutting spending only makes the recession worse. The solution is for the government to spend more for the simple reason that no one else will. You can call these policies Keynesian, but I call them essential.