Economics: The Theory of Earning and The Theory of Spending

Our previous post attacking the inheritance of wealth is not without a precedent in economics.

See The Economics of Inheritance (1939,1971) by Josiah Wedgwood (Director of the Bank of England 1942-1946 and owner of Wedgwood ceramics – the famous “Wedgwood China“)

“in which he [Wedgwood] attacked the principle of inherited wealth.”

As written at Josiah Wedgwood:

“Like many radicals at the time, Josiah Wedgwood was deeply influenced by the writings of Henry George. After reading Progress and Poverty Wedgwood wrote: “Ever since 1905 I have known that there was a man from God, and his name was Henry George! I had no need thenceforth for any other faith.” In Progress and Poverty [1877] George argued that the gap between the rich and the poor could only be closed by replacing the various taxes levied on labour and capital with a single tax on the value of property.”

Our previous post on Milton Friedman’s “economics of spending” does not mean that we are not capitalists. Quite the contrary, we are staunch capitalists – it is clearly the most pragmatic of all possible economics. However, any economic “theory of spending” must also have a comparable “theory of earning”. When we plug the search phrase “theory of earning” into Google, we get only 12 hits as compared to 105 for the “theory of spending”. Not only is an economic “theory of earning” nearly non-existent, but an economic “theory of spending” is also unexpectedly sparse. What on earth do the economists research??

Mike Alexander has a page devoted to the sparsely found “Spending Theory“, which analyzes the Harry S. Dent view in The Great Boom Ahead (1993) which concludes that spending is determined by demographic factors.

Alexander writes:

“Dent proposes that economic boom times are associated with increasing size of the mid-forties population, the major ‘spenders’, and that bust times are associated with a decreasing size of this population. He calls these oscillations in the number of middle-agers (at their peak-spending years) the spending wave.”

Interestingly, Dent in his book The Roaring 2000s (1998) calculates that immigration boosts spending with a 14-16 year lag since the average age of immigrants (in the USA) is age 30. Hence, writes Alexander, for Dent:

“it is the absolute changes in immigration (or birth) rate that affect the economy [years down the road].”

However, writes Alexander, a theory of spending must also take into account the theory of earning:

“What can explain the post-war boom were the strongly rising wages during this period, reflecting strong productivity growth. Two things are required for there to be a rise in spending. One is the desire to spend and the other is the means to spend. The first ought to be influenced by the population-relative spending wave in much the way that Dent hypothesizes. The second depends on growth in people’s earnings and the employment level. We can construct a “wage-adjusted” spending wave by multiplying the smoothed spending wave by the product of the median real wage and the percentage of workers who are employed. This adjusted spending wave correlates well with the post-war stock boom. Clearly, there was a spending wave in the 1950’s and 1960’s that arose not so much from an increase in the propensity to spend (demographics), but rather, from an increase in the ability to spend (wages & employment).

The adjusted spending wave shows a peak in 1969 and then a long decline until the early 1980’s, reflecting the combined effects [of] the rapid fall-off in the unadjusted spending wave after 1969 and stagnant wages after 1973. The rise of the wage-adjusted spending wave in the 1980’s and 1990’s reflects the strong growth in the middle-aged population after 1982, even though wages have remained stagnant. If the economy were to fall into recession in 2001, as seems increasingly likely, wages would likely fall in real terms and unemployment would certainly rise. We can use the relative changes in wages and employment during the 1990 recession as a template for predicting how the wage-adjusted spending wave might change after the year 2000 if we were to have a recession. … We find that, assuming a recession beginning this year, the wage-adjusted spending wave will have peaked in 2000, suggesting that the stock market peak in 2000 (and not some later peak around 2007) was the end of the secular bull market.” [emphasis added]

The way it looks to us, Alexander’s analysis has been proven correct. Although the demographics are present for increased spending at the current time, there has not been a necessary growth in people’s earnings or in their employment level. In the USA, the rich have been becoming increasingly richer (partly due to stupid tax refunds made by the Bush administration) and the poor have been becoming increasingly poorer, with the middle classes being dried out economically by greed at the top levels of the wealth ladder.

Indeed, the Bush administration tax refunds have been taken out of a government budget surplus which constituted assets of “all of the people” and put into the hands of the better-earning few, who have put that money back into treasury certificates, etc. – i.e. have loaned that same money back to the government to creat a budget deficit – whose interest payments “all of the people” will have to pay down the road. Some people have thus been made much richer and many have been made much poorer – this is the economic legacy of the Bush administration (note: we otherwise are generally favorable to the Bush administration in foreign policy).

Essentially, our analysis supports the most elementary conclusions of Keynesian economics. As stated at ECON 6030 STUDY PROBLEM #1: KEYNESIAN MACROECONOMICS by Roger W. Garrison, Professor of Economics at Auburn University)

“The workers’ loss of income means reduced spending, but spending isn’t reduced as much as the reduction in income (This is the key implication of Keynes’s consumer-spending theory: … Income and expenditures spiral downwards until … excess inventories are dissipated–at which point income equals expenditures, and the economy is in macroeconomic equilibrium….”

“The income level needs to rise if prosperity is to be achieved, but the market process (as envisioned by Keynes) will instead cause income to fall–until the level of savings is just enough to finance the current level of investment and government spending. This sort of perversity is characteristic of the market system according to John Maynard Keynes’s 1936 book, The General Theory of Employment, Interest, and Money.”

Keynes’ major contribution to economics in that book was the following:

Distinguished British economist John Maynard Keynes (1883-1946) set off a series of movements that dramatically altered the ways in which economists view the world. In his most important work, The General Theory of Employment, Interest, and Money (1936), Keynes critiqued the laissez faire policies of the day, particularly the proposition that a normally functioning market economy will bring full employment. Keynes’ forward-looking work transformed economics from merely a descriptive and analytic discipline to one that is policy-oriented. For Keynes, enlightened government intervention in a nation’s economic life was essential to curbing what he saw as the inherent inequalities and instabilities of unregulated capitalism.

[Amazing here is that politicians in Germany do not understand the implications of Keynesian theory for Germany’s unemployment problem and we would not be surprised if most of the Schroeder cabinet had never even heard of Keynes. It is rather incredible that such economic incompetents are running one of the world’s leading economies.]

In any case, rather than concentrating on a sensible “theory of earning”, the economists wander about – sometimes aimlessly – in the world of capital, envisioning only that CAPITAL and its INTEREST (i.e. accumulated and mostly INHERITED viz. GRATUITOUS wealth profiting from “earners”) – rather than POLICY and LAW (as in the case of inheritance or in achieving full employment), are the key to modern economies, without however analyzing the effects of “inherited wealth” or “gratuitous wealth” on those same economies.

By “inherited wealth” or “gratuitous wealth”, we mean here not only wealth that passes in testate (i.e. by a testament viz. will) but also include such inherited wealth and CAPITAL as private or government oil fields, etc., which confer “income” on the owners without their actually “earning” anything by work or talent. An owner of an oil field becomes wealthy because he has obtained ownership of the oil field and subsequently farms out the work to working “earners”. Many oil-producing countries have thus become phenomenally wealthy while others do the work. This kind of non-earned money tends to lead to evil ends, not only in oil-producing countries but all over the world. People who have not “earned” the money by either work or talent are given the means to make economic and political decisions which affect the world. This can not turn out well in the long term since people obtaining “freebies” are major policy makers for a world which can only survive if the “earners” earn.

Friedman sees the worst possible alternative of his four listed spending possibilities to be his number four:

“Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.”

We see the worst possible spending alternative to be an unstated FIFTH:

“Worst of all, I can spend money I have not earned on endeavors to make the world a worse place for everyone who does not believe the way I do.”

We need only study man’s war-torn history, not just merely current events, for myriad examples of this type of economic spending. Indeed, most governments fall into this fifth alternative category of spending, pushing their own private views of the world rather than trying to make that world a better place for their citizens.

When economists talk about capital and interest rates, they have to look to who it is that has that capital, how they got it and what interests drive the economic and political decisions of the controllers of capital. Then one can talk about money supply and interest rates and not before. A prime example of this principle are oil prices, which are determined politically and selfishly by oil cartels (otherwise illegal in capitalist systems) who control accumulated wealth which they themselves largely have not earned but which wealth is produced for them by external technology, external workers AND external consumers. They merely “sit” on the land where the oil is located. This lack of any connection between “having” wealth and actually “earning” that wealth leads to bizarre spending patterns by those controlling that same wealth. It is not necessary here to list them – everyone knows what they are.

If the people who “earned” the wealth of the world made the decisions – and this is one principle of democracy in permitting every citizen to vote and having that vote count equally as every other vote – then things would look better, as they do in the capitalist countries of civilization, such as the USA, where decisions to spend accumulated wealth are still connected – if imperfectly – to the will of the majority of “earners”. Such earners will tend to spend money for things that benefit THEM and THEIR interests in the long term. In countries such as many of the oil-producing nations, where democracy is not present in fact, tyrannical rulers or ruling privileged luxury oligarchies spend accumulated non-earned wealth to create worldwide political, social and military problems and to push their belief systems on others.

Strangely, on the macro-scale of nations, most people understand fully what a terrible thing the accumulation of wealth in the hands of “non-earners ” is. At the same time, those same people have trouble admitting that inheritance of wealth at the lowest level, i.e. personal inheritance by individuals, is equally undesirable.

So, the world continues to honor men who inherit wealth and do nothing, as some of the wealthy nobility of Europe do and dishonor men who do not inherit wealth and do nothing, as some of those who inherit nothing do. But both are doing nothing and are actually equals, from the standpoint of the economic needs of the world. Only “their” wealth is working – and that need not then be in their hands – it can be elsewhere.

Let a man earn what he can, and he will likely spend that money sensibly. Give a man his wealth without having earned it, and his spending will likely be inimical to societal needs in the long term. That is our theory of earning and spending.

There are of course exceptions to every rule. We have good friends who have inherited wealth and are doing wonderful things with their inheritance. So in some cases inheritance works.

But vast numbers of men around the world with similar fortunes do nothing for humanity – indeed, quite the contrary, they either spread violence and misery or spend their time in the vanities of money. Hence, the exceptions can not be used to make a general rule for all.

In closing, we must distinguish capital “earned” and capital “gratuitously received”. We look with great admiration to a man like Bill Gates of Microsoft – an “earner” rather than “inheritor” of his accumulated wealth – who is putting that wealth to work for the good of all through his Bill & Melinda Gates Foundation. And that is as it should be.

Who is making this world a better place: Bill Gates or the oil-producing countries?

The answer is clear, even if we occasionally have trouble with Windows XP.

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