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Boosting consumption

By Morgan Sherburne
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More, more, more

Want to boost the consumption rate in the United States? Transfer wealth from the top 20 percent of earners to the bottom 80 percent, according to a University of Michigan study.

The study is the first to consider the interplay between consumption, income inequality and wealth inequality, and found that such a transfer could boost the total consumption rate by about 3 or 4 percent.

Previously, studies had considered the effect of income on consumption, which is the measure of the goods and services you buy daily, including what you pay for your car or bus pass, groceries, clothing, and health care. But it’s important to also take into account wealth, which comprises the savings and other assets a person might own and resources that person might draw on if he or she falls upon hard times.

“In economics, there’s this theory that people tend to smooth their consumption,” says U-M researcher and study author David Johnson. “Even if your income goes up or down, you’re going to spend at a certain rate, saving for a rainy day, and if that rainy day comes, use those funds. The goal of our paper is to simulate how you respond to your income going up or going down.”

Shop till you drop

“Even if your income goes up or down, you’re going to spend at a certain rate, saving for a rainy day, and if that rainy day comes, use those funds. The goal of our paper is to simulate how you respond to your income going up or going down.”
What Johnson and colleagues found is that less wealthy people had a higher marginal propensity to consume, while wealthier people had a lower consumption rate.

Wealthier people spent more money as a whole but had a lower rate of consumption: everyday requirements such as groceries take up a smaller percentage of their budgets. Also, they have deeper pockets to dip into if they have an unexpected bill to pay, which made them less reactive to changes in their income.

Less wealthy people had higher consumption rates, and they were less able to keep a stable consumption rate if their incomes changed, according to the researchers. Hurdles such as a broken-down car or health emergency aren’t as easy to pay because they don’t have the funds in savings, or have more difficulty applying for credits or loans to pay for the emergency.

Examining only the effect of income on consumption doesn’t take into account, for example, a retiree whose income might be low, but who might be drawing on retirement savings.

Growth is good

The study uses data from the Panel Study of Income Dynamics, which has traced the financial lives of the same families for 50 years. The PSID is housed within the Survey Research Center at the U-M Institute for Social Research.

“In order to really evaluate the rate of consumption, you have to look at income, consumption, and wealth together,” says Johnson, who is the director of the PSID. “The Panel Study of Income Dynamics is the only dataset that has all three.”

The researchers also calculated what would happen if some wealth was shifted from the top 20 percent of wealthy people to the bottom 80 percent. They found that total consumption would increase by 3-4 percent.

“A redistribution of wealth might lead to higher growth, and growth is good,” Johnson says. “You’re still taking away from somebody, but overall, it’s better.”

The study is published as a working paper online at The Washington Center for Equitable Growth.

Morgan Sherburne

Morgan Sherburne

MORGAN SHERBURNE is a writer and public relations representative at Michigan News. She specializes in social research and the physical sciences. Prior to working for U-M, Sherburne was a reporter in Petoskey, Mich. and a science writer for University of Florida Health. She has a master's in science writing from the Massachusetts Institute of Technology, a master's of fine arts in nonfiction from the University of Minnesota, and bachelor's in literature and creative writing from Grand Valley State University.

COMMENTS

  • Jeff Richied - MBA95

    I’ve tried to make this argument before and it makes total logical sense. If 2 ppl get an extra $1000, Person A makes $30K & B makes $300k. Person A is obviously going to spend more of the $1000 which increases consumption and money flow, which will drive GDP & stock valuations higher. I’m glad to see UM apply some science to this topic. Hopefully this study furthers the discussion that we need to enact policies that benefit those who earn less as it will drive higher consumption which will drive stock prices up. The whole assumption that redistribution of wealth to the poor is bad or not fair is bull. Weren’t the recent corporate & wealthy tax cuts a redistribution of wealth to the rich? So why didn’t conservatives lose their minds about that redistribution of wealth?

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    • John Galt - 1999

      I am sure whoever you will be giving all your extra money to will be very happy! I won’t be surprised when they knock on your door asking for another hand out month after month after month. Good luck with redistributing your wealth.

      Reply

      • John Oldenburg - 1970

        Ayn Rand devotee?

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      • susan baird

        Excellent point Galt – you learned well and throughout the history of mankind, redistributing wealth has NEVER worked. Jeff, give out your income first and let’s see how you like that :O

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    • Ram Cerda - 1997

      In your example, I would think that Person B’s consumption is steady and consistently greater than Person A’s. For example, Person B’s “consumption” may be at 30% on a monthly basis while Person A’s is at 3%. With an extra $1,000 given to both people, Person B’s consumption will most likely stay at 30%, but Person A’s will increase to 5%, 6%, 7%? Regardless, it is Person B’s consistent consumption that is driving the economy.

      Reply

    • John Galt - 1999

      So true!

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    • Joseph Brooks - 2005

      > Most people are poor because they have bad money management habits and “poverty thinking”.

      But that seems to be the point this article is making. If poor people = “bad money management” = spend every dollar they receive, and rich people = “good money management” = save most dollars they receive … then in order to boost consumer spending, you should redistribute to poor.

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  • John Galt - 1999

    You have got to be kidding. This is what we call science? Give poor people money and they will spend it, you needed a study to come to that conclusion?
    “Wealthier people spent more money as a whole but had a lower rate of consumption: everyday requirements such as groceries take up a smaller percentage of their budgets. ”
    So the basis of this research is on how much money a person of a certain class spends daily and what the ratio of the amount spent versus their budget. So if you give people who have very little, more money and they spend that money, it increases that ratio, and therefore is good for cosuption and thus the economy is better off. That is a joke. So if a person spends 100% of their monthly income in the given month, you are saying that it is better to take money from someone else, who earned it, and give it to someone else just so they can spend 103% of their monthly income? And by doing that it will generate growth, and growth is good.
    What happened to going to college to get a degree to make something of yourself so you could better your life and the life of your family? Or even just working hard in a blue collar job and doing the samething?
    Because what you are proposeing is that it would be better to not try because someone is going to give me money and other goods that I need to survive. And by me not doing anything I would be helping by over spending. So what happens when there are no more “evil” (<– my word, not the study's) rich people to take from?
    Lastly, why is it that all these people that come up with this position don't freely give their own money to anyone? I mean if you have more money than you need to meet your daily spending needs, then why are you keeping any of the excess? How can you justify having a savings account with money in it, a 401(k) or any other retirement plan? If you have a college savings plan for your child(ren), how is that not a gross insult to those on the other side of the inequity equation? Because if the goal is to get everyone equal you should not have anymore than you need, correct? It is interesting that all these studies do not look at the human elements. Everyone is willing to help… to a point. We all have a limit to how much we will help. Yet this study literally says that if you steal from someone to give it to someone else, it is ok because it helps with consumption. Do we then change the laws as well? Because I am fairly certain that when people break into houses and steal other people's belongings, steal from stores, rob banks, or steal money/funds from businesses that the proceeds from thise actions also lead to an increase in consumption; however that is just a theory as I do not believe a study has been done on this point.

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    • Jim Hallett - BA '72

      I love your handle (John Galt, as Atlas Shrugged is one of my all-time favorite books!), and you are so right. No matter that history is littered with continuous failure with socialist/communist systems, those in academia keep promoting this garbage. People are NOT equal and NEVER will be. Issuing policies (code for more theft and coercion, which the govt. specializes in) to create such an unattainable goal only makes things worse. Capitalism (and the West does not have true free market capitalism, so it is a handicapped application of it) has created all the advancement the world has seen. Perhaps, people who fancy this kind of socialist nonsense would enjoy living in places like Venezuela. Individual freedom and the ability to create the life one desires without interference from criminals like the govt. is the only way to provide for an advanced and desirable world.

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    • Susan Baird - MBA '85

      Well said handle John Galt – my license plate is Galt1 for me and Galt 2 for my daughter :) Thank you for posting my thoughts too. I have felt better after reading so many other alums responding to this flawed “study”.

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  • David Doll - 1980

    Mr Johnson’s study is of no value. Stealing from one segment of the population to give to those that spend their net worth every week will of course boost consumption, but the ripple effects through the economy will be short lived. I suppose the authors would applaud subsequent rounds of “wealth transfer” from those that benefited from whatever short term growth was created. Socialism is not a new concept – it has failed societies throughout history. Winston Churchill was reported to have said “Socialism is a philosophy of failure, the creed of ignorance, and the gospel of envy, it’s inherent virtue is the equal sharing of misery.” If this is the type of research the university funds and publishes, I would suggest those with net worth stop contributing as socialism will provide for the schools needs (I won’t be). I am very disappointed to have seen this article published in this newsletter.

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    • Dr. John Welch - 1970

      So with this newsletter article, I am reminded why I no longer contribute to my beloved Michigan in the same way I would not fund an errant child’s financial irresponsibility. Why don’t the researchers just say, “Our conclusion is that it is time for big universal basic income cheque in the amount of the mean income of a PSID family, and let us all enjoy universal basic consumption…no more, no less.” There’s a guy on display in the Kremlin in a glass coffin who beat you to it with the same idea. The terrain of capitalism is peaks and valleys. Get used to it..it shouldn’t be that hard for a M grad.

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      • Fred Wildebeest - 1974

        John and John, It is certainly disappointing to see a UM “researcher” who’s thinking is so shallow. And I agree, it is precisely why I, too, no longer contribute to the heavily socialist big U. From an economics standpoint, Johnson completely misses the concept of velocity of money, that savings do not just “sit” somewhere. Savings actually speed the economy by supporting borrowing and/or investment, which very obviously stimulates more economic activity. And round and round it goes. Whereas, a one-time “boost” to consumption is simply a one-off event (not to mention the behavioral aspects cited above) and does very little to stimulate true, sustainable growth. Perhaps when the Econ building got torched several years ago some of the better minds went with it.

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  • Brian Gasiorowski - 1978

    While in my mind there is definitely merit in the Dave Ramsey financial teaching as well as our free enterprise system that incentivizes individuals to personally strive for excellence – I nonetheless favor sharing the fruits of my labor and am agreeable to rationale added taxation as a policy tool to deal with wealth inequality. There is truism that many in the bottom 80% make many bad choices that I – at some level of thinking – should not be responsible for. It is sad that so many are “takers” and often really don’t appreciate the givers. But as long as I’m a functioning human being with the mental capacity to do so – I will strive to be one of the givers and love and respect others as best I can.

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  • Tom Carlson - 1977

    This failed idea has been the basis of our government handout programs for the past 65+ years and has resulted in no less poverty due to the inability of the recipients to effectively manage their gifted monies. The lack of awareness of wants vs needs and the preference to satisfy vices over achieving any sort of social goals that was expected to be accomplished with the finances is sadly obvious, even to those of us without degrees in economics or sociology.

    Reply

  • Dan Gliebitz - 1988

    An additional argument for wealth redistribution is that the wealthy have more money to invest in their children’s education. This serves to perpetuate and even worsen wealth inequality. Meanwhile, the economy misses out on undeveloped human capital that goes to waste in the bottom 80% of the population.

    Reply

  • Douglas Griffin

    “Be careful what you wish for!” Increased consumption equates to increased pollution, increased green house gasses, increased garbage, and so on and so on…

    Without dramatic changes in technology, the environmental health of the world can’t take a significant increase in consumption.

    Reply

  • Dan Ouellette - 1984

    The researchers must assume that financial resources of the top 20% are stored in a mattress and doing nothing for the economy? Wrong, much of whatever is not spent for “consumption” is in a bank where it is available to others in the form of loans. Loans to consumers and especially businesses are valuable to the economy and lead to overall economic growth. There is nothing in the socialist playbook about real growth – only moving buckets of water from end of the pool to the other.
    I also no longer contribute to my beloved UM since much of their philosophy doesn’t align with mine. Walk around campus and note the wonderful facilities and their continual update through construction projects – UM is not hurting for money. I instead contribute to Hillsdale College.

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    • Dan Gliebitz - 1988

      I don’t think that anyone can claim definitively that investment is more important than consumption for economic growth. Economists have been arguing about this for a long time.

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      • David Moorhead - 1984

        I don’t think that anyone can claim definitively that consumption is more important than investment for economic growth.

        Fixed it.

        Reply

        • Dan Gliebitz - 1988

          I am not sure what you think you fixed. You seem to be countering an assertion that I did not make.

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  • F Hayes - 1984

    This is research? Not even close. This is a very simple liberal agenda that started with a conclusion and applied some errant grade-school math to rationalize its message. How do you sustain this newfound consumption? At some point, higher earners lose the incentive to work harder and longer if the reward for their efforts iis arbitrarily taken away, and we revert back to the lowest common denominator. I am reminded of Margaret Thatcher’s comment: “The trouble with Socialism is that eventually you run out of other people’s money.” Very disappointed that the University actually funds such shoddy work. I will be questioning all further alumni donations.

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  • Barbara Goist-Marsolek - 1961

    I have worked with the underprivileged for years even running a free clinic in a small town in OK for 8 years. These people need a lifeline in self confidence and not a handout. Give them a meal and follow-up with a way to better yourself even starting with fast food. You would be surprised at how much a job helps your self-esteem. As soon as they were given disability under the Obama administration which was frequent for no apparent disability except for a good lawyer with ties to a judge, it was manna from heaven. They still lived in poverty and did not move or try to better themselves. Socialism is not the answer although after reading in the Wall Street Journal on 6/18/18 about the “Bias Response Team at UM” and the UM President, Mr. Schlissel’s response to the students who voted for Mr. Trump is appalling. My money may go to Motts or else St. Jude, no longer to just UM.

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  • Susan Baird - MBA '85

    Thank you everyone that took the time to write out their experience with various forms of Socialism and that it does NOT work. When I read this idiotic article my first reaction was – is this from my beloved, highly ranked alma mater that is supposed to be at the for front of problem solving? I would hope that UM would review their “studies” so stupidity like this would not make it’s way to the public. Dr. John Welsh and others, I have reduced my contributions to socialist promoting institutions as well. Can not fund destruction. The best charity is a good job!

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  • Patrick Cardiff, Applied Economics - 1990

    Ah, why do the Libertarians insist on seeing Economics with such blinders? Look, it’s more than private interest we’re referring to here. We have a consumption economy. Our GDP (if that’s what you wanna use) is 2/3 consumption (as in C+I+G+(Net Exports)). When poor people spend more, the multiplier affects a larger, lengthier, deeper set of locations, and ya know, life gets better (if consumption is what you wanna call “life”). Nobody’s trying to take your money, OK? We’re trying to stop up Okun’s leaky bucket a little, with more efficient, direct transfers from the government to poor people. It’s working in a number of places already. “Enlightened civilization” of the 21st Century should help the poor!

    Reply

  • Wanda Smith - 1973

    Discussions like this, I want to weep. No, I have not given away all my money. Yes, a portion, and I should do better. No, I don’t attend church. Yes, I consider my connection with the Great Spirit as the most important action of my life.

    The capitalist system is broken. Judgement of others as less deserving is a symptom that we have lost our way.

    The exemplary man who was Jesus told us to love our neighbor as we love ourselves. He did not mention that that neighbor must be deserving.

    This is taken from Richard Rohr’s Daily Meditation, from the Center for Action and Contemplation, Wednesday July 18th, 2018. The quote is by the unknown to me “poet, peacemaker, minister and scholar John Philip Newell”:

    “Think of the hubris of our lives. Think of our individual arrogance, the way we pursue our own well-being at the neglect and even expense of [others]. . . . Think of the hubris of our nationhood, pretending that we could look after the safety of our homeland by ignoring and even violating the sovereignty of other lands. Think of the hubris of our religion, raising ourselves up over other wisdom traditions and even trying to force our ways on them. Think of the hubris of the human species, pretending that we could look after our own health while exploiting and endangering the life of other species. . . .”

    I see myself here, and I don’t feel good about it.

    Reply

  • David Moorhead - 1984

    The notion that wealth is a static fixed commodity that has to be divided up politically is ridiculous.

    Wealth is a dynamic resource, grown through innovation and free enterprise. Not some central government picking winner and losers.

    Countries that have become wealthier have done it by encouraging innovation and free enterprise, not by central planning and control.

    Reply

  • Abigail Welborn - 2004

    Since everyone seems so horrified by the idea of wealth transfer, I skimmed the paper and could find no mention of stealing people’s incomes. A 92% top marginal tax bracket is pretty close to that, and that was in effect just 65 years ago. (https://www.taxpolicycenter.org/statistics/historical-highest-marginal-income-tax-rates)

    No one’s saying anything about a planned economy or taking all the money and redistributing it (communism). If we simply made our taxation system as progressive as it was designed to be (e.g., by making capital gains the same as ordinary income), everyone would benefit, even those paying more tax, because a rising tide lifts all boats.

    The problem of consumption having negative social and environmental effects is still real, but that’s a separate question. For now, consumption is the main driver of economic growth, so the point of the paper stands.

    Reply

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