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Paul Krugman recently complained that the rich were going back to the days of conspicuous consumption. While I sympathize with the pain caused to non-rich liberals when the rich live large, I do wish they would make up their mind about what they want the rich to do.

Krugman is complaining that the rich are spending their money and enjoying the spoils of their hard work and success. This is odd because usually the liberals complain that income inequality is bad because the rich do not spend enough of their money. Liberals, adherents to Keynesian economics, incorrectly believe that consumption (spending) is good for the economy and saving (which leads to investment) is bad.

The idea seems to be that money which is spent boosts the economy, but money which is saved disappears. It is as if the liberals believed that the rich kept their savings either stuffed in their mattresses or buried in their backyards. Yet I promise you that Paul Krugman does not keep his savings in a mattress or backyard. In reality, everyones savings are taken by banks and lent out to somebody else who wants to spend it. Thus, saving is just as good for the economy as spending.

Liberals have made a habit of supporting income redistribution because of the fact that the poor will spend all of the money they receive, while the rich save too much. Former Speaker Nancy Pelosi repeatedly declared extended unemployment benefits a stimulus program under her theory that the recipients would spend all the money (unlike the rich who were explicitly or implicitly blamed for hurting the economy with their lack of spending).

Paul Krugman (Photo credit: Wikipedia)

Yet the money to fund those benefits came from government borrowing, meaning that a rich person had to save the money first. If nobody ever saved money, the government could not borrow it. In that sense, it should be obvious that saving is equally good for the economy as spending since one is easily transformed into the other through either the miracle of government redistribution or a bank loan.

Just in case anyone tries to escape this simple point on a technicality, lets get technical for a minute. If I spend a dollar, one dollar goes into the economy. If I save a dollar, not quite the whole dollar gets lent out because banks have to keep some in case their depositors want to withdraw some of their money. On average, a fair number is that 10 cents gets lost from the economy as bank reserves while 90 cents gets borrowed and then spent. This makes it look like spending is, indeed, better than saving.

Unfortunately, it is not so simple. Some of what we buy consists of imports. When you buy an imported product, some of the money leaves the economy to pay for the imported products. Across the entire U.S. economy, imports equal 17 percent of GDP. That means spending is actually worse for our economy than saving (in the sense of more money disappearing from circulation). So actually, the economy might grow faster if we redistributed income from the poor to the rich (not that I am suggesting that).

In fact, the advantage to rich peoples money is even bigger. It turns out that poor people spend their money mostly on things (food, shelter, clothing) while the rich spend a higher percentage of their money on services (spa days, personal chefs, luxury travel). This implies a higher percentage of the poors spending is on imports because generally you import goods, not services. The poor are shopping at Walmart where many products are imported while the rich are spending their money on domestic services like manicures. This makes a rich persons spending potentially even better for economic growth because more of it stays in the economy.

The morale of this story is that income distribution does not matter for economic growth. Yes, rich people save more money than poor people, but that is good for the economy, not bad. Rich people also buy fewer imports, which is also good for the economy. Redistributing income from rich people to poor people does not boost the economy. Yes, it produces more consumer spending and less saving, but that just means less investing and borrowing. In the short run, it has little effect on GDP because consumption and investment both count the same. In the long run, less saving, investing, and borrowing means fewer jobs and a poorer nation. Thus, redistribution actually has no effect initially and makes future generations poorer (Robert Solow won the 1987 Nobel Prize in economics for this, so it is not exactly a recent breakthrough in economic knowledge; Paul Krugman has undoubtedly taught students that very fact).

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Paul Krugman And Liberals Need To Decide If They Want The Rich To Spend Or Save Their Money