Macroeconomics for a Post-Material Future

If our future is indeed post-materialist, we need to worry about how our economy will get unhooked from material consumption as its source of enough economic activity to employ all those who want to work. If anything does, the revival of downtown living symbolizes the post-material form of life to which younger generations increasingly aspire. Downtown living emphasizes shared public experiences in contrast to spatially expansive suburbs oriented to the private accumulation and enjoyment of material possessions. If you live in the suburbs you are more likely to own a spacious dwelling and one or more motor vehicles than if you live downtown. If you live downtown, you are more likely to dwell in a compact apartment or condo and get around on foot, by bike, or on public mass transit than if you live in the suburbs. In short, life in the suburbs encourages entropic consumption, and downtown living facilitates entropically benign experiences. Unsurprisingly, over the last half century, the rise of the consumption-oriented suburb has been an essential element in a U.S. consumer-driven economic expansion. Post-materialism suggests a different future that necessarily looks beyond consumption as the dominant force behind macroeconomic demand and employment. To the prospects for this we now turn.

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In a materialist world where consumption is paramount, a maximal flow of consumer goods distributed over one's lifetime drives economic decision making. For a materialist, the prime desire is for more income and more consumption, and growth in both is a very good thing, and coincidentally, it's also good for the macroeconomy and employment. More spending at the mall, or another Amazon order, brings both personal pleasure and more income and employment. Added income will be quickly re-injected into the spending stream bringing still further employment increases. Advances in consumer spending are the mother’s milk of a high employment economy. Conversely, a collapse in consumer spending brings forth a crashing economy and an explosion in unemployment. To see how this works, lets introduce a few macroeconomic ideas and do a quick review of our most recent economic traumas of the 2007-2009 Great Recession.

To understand the causes of economic decline even at the simplest level, we need to know something about the key measure of our country’s economic output, Gross Domestic Product, in shorthand, GDP. GDP measures the total market value of all final goods and services produced within a country’s borders in one year. For 2013 in the U.S., this number equals $16,800 billion. Final goods and services are newly produced during the year and go to the final owner, including consumers, businesses for additions to their productive capacity, governments, and to net exports (exports minus imports). The single biggest recipient  of output in 2013 was consumers at 68 percent of the total, the dollar amount of which is symbolized by C. The next biggest recipient of final goods and services is government (denoted by G) for 2013 at 20 percent, and following this is private sector investment (I) at 15 percent. The tail end of the list is occupied by net exports (X) and it comes in for 2013 at a minus 3 percent. This category equals exports minus imports and ends up negative because we import more than we export. The elephant in the room that truly matters for the economy as a whole is clearly consumption.

The Great Recession of 2007 to 2009 has its roots in a housing market boom that began in the early 2000s and culminated in a precipitous decline in housing prices in 2007. Between 2007 and 2009, the economy shed 8.5 million jobs and the unemployment rate rose from 4.7 to 10.1 percent. In comparison to a long-term trend line, consumer spending in 2011 stood $7,300 per person below what it otherwise would have been had the recession not occurred. Of the total jobs lost, about a third can be attributed to the decline in consumption, and most of the rest to a precipitous drop in investment spending. Whenever the economy as a whole slows down, businesses immediately cut their spending on additions to their capital plant and inventories. Businesses add productive capacity whenever more sales are expected, but the rug will be quickly removed from such expectations by a financial panic and economic decline, and this is exactly what happened in 2007 and 2008. The real culprit in getting the economic ball rapidly rolling downhill, was residential housing construction specifically, and reduced spending related to the housing market generally. From its peak in 2005, residential construction declined from $856 billion and 34 percent of investment spending down to $392 billion and 21 percent in 2009. Historically in recessions, households move slowly in cutting back spending, but special circumstances prevailed in 2007-2008 that sent consumer goods purchases tumbling. To this issue we now turn.

The bursting of a housing bubble in 2006 in combination with a highly speculative and fragile financial system set the stage for a rapid plunge into recession starting in late 2007. From 2001 on, low interest rates, unusually lax mortgage lending standards, and the creation of subprime loan instruments that extended homeownership to families who don't ordinarily qualify for conventional mortgages brought about a boom in both new housing construction and purchases of existing housing, driving housing prices rapidly upwards. A housing boom functions through a contagion of optimism characteristic of financial booms generally, the nature of which Robert Shiller convincingly describes in his book, Irrational Exuberance. A desire to get on the bandwagon of rising prices fueled growth in the homeownership rate to a new high by 2006. Homeowners took advantage of rising values by getting their hands on huge amounts of spendable cash through mortgage refinancing at low rates and home equity loans, and much of this new cash went to funding a boom in consumer purchases. A rise in housing values well above historical norms couldn’t last, and prices came tumbling down, dramatically reducing household wealth and driving many homeowners underwater with home values falling below outstanding mortgages. Unsurprisingly, mortgage defaults accelerated, a story that is familiar to us all. With a drastic decline in the worth of their most valuable asset, their house, and extraordinary debt obligations, consumers had little choice but to curtail their spending. With the slowing of the economy, businesses began laying off workers in the face of shrinking product demand and cut back on investment spending leading to further layoffs in construction and capital goods industries. Needless to say, new housing construction dropped precipitously putting a huge dent in construction employment. The economy probably could have recovered from the drop in new housing construction, but once housing value declines took hold and home loan defaults began to rise, the writing was on the wall.

The tale of financial market woes following the housing market crash is complex in its details but conceptually fairly simple. From the early 2000s on, financial institutions packaged mortgage loans together into securities in increasingly novel and innovative ways, and sold them to investors to the tune of trillions of dollars. Unbeknownst to investors, many of these securities were at high risk for default even though rating agencies put a low-risk stamp of approval on them. At the same time, a huge array of other financial instruments, many based on fragile pyramids of underlying asset valuations, were also being created. In short, with the bursting of the housing market, this whole system of new and novel financial instruments came tumbling down, stock markets around the world plunged, and a number of U.S. financial institutions had to be bailed out by the Federal Reserve to save the economy from a free fall.

 Not only did the U.S. Federal Reserve undertake unprecedented financial rescue measures from 2007 to the present day to save the economy from economic depression, but the Obama Administration and Congress put into effect an economic stimulus plan amounting to nearly $900 billion dollars. Without this and other government measures to stabilize and stimulate the economy, no doubt we would today be referring to the Great Recession as the Second Great Depression. During recessions, depressions, and financial panics, consumers and businesses withdraw spending from economic circulation, bringing forth economic decline and rising unemployment. This was the simple insight of John Maynard Keynes, and brought him to conclude that in depressions and recessions government will be the only institution left standing with the power to replace lost spending and recharge the demand for goods and services. The historical proof for this is wartime military spending in the 1940s that finally brought an end to The Great Depression of the 1930s. The Obama Administration in the American Recovery and Reinvestment Act of 2009 instituted government spending increases and tax reductions to stimulate the economy including new infrastructure projects, transfers to budget strapped state and local governments, boosts in assistance to the unemployed, a social security tax holiday, and other tax cuts. One estimate suggests that this effort increased jobs by 2.7 million workers and cut unemployment by 1.5 percentage points. The usual complaint with fiscal policy of this sort is its deficit financing, but without a concerted fiscal and financial effort to turn the economy around, economic decline would have caused the deficit to increase by much more than it actually did. 

The essential thought I hope to leave you with here is this: government spending and tax measures can be brought into the breach where private sector spending is not up to the task of employing all those who want to work.

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For post-materialists, consumption is important, but only insofar as it serves the experience of life. This infers an upper limit on lifetime consumption and income flows, above which more interferes with desired life experiences. One needs time and the opportunity to smell the roses, and many of those roses lay outside the arena of private consumption. To the materially satisfied, another day at the park, riding one's bike, or reading a book at the library will look better than work or shopping. For post-materialists, income increases will just pile up in savings rather than go to spending. For materialists, some portion of any income increase will instead be devoted to expanding consumption. These two different behavioral regimes will have differing effects on the country's macroeconomy.

To get a clear picture on economic consequences, let's begin with a simple but extreme case where we all convert to post-materialism in one fell swoop and achieve our desired upper limit on consumer spending right away. In a materialist world we were all happy to expand our acquisition of material goods along with growth of our incomes over time, but now we have lost interest in this and prefer to spend our time in other pursuits. As we described above, the economy as a whole is composed of four sectors responsible for spending on newly produced goods and services : consumption, investment, government, and net exports (the last of which is small enough for us to ignore). Consumption is the elephant in the room at around 65 percent of the total pie, so if it suddenly stops growing, it truly matters. To keep the story from getting too complicated, let's take population and the labor force to be stable, meaning that growth in the supply of real (inflation adjusted) GDP comes entirely from labor productivity improvements that flow from various sources including better education and job training, more capital goods such as computers and manufacturing robotics, and more efficient technologies. If productivity rises by 1 percent a year, this means we all have to spend 1 percent more or else we won't have bought everything our economy can produce, and we won't have fully employed all its resources, including labor, and unemployment will rise. In short, the spending treadmill needs to speed up each year by the rate of productivity improvement, or else we won't need as many total hours of employment. Spending less than an added 1 percent will require either layoffs or per employee hours reductions, and, in the U.S., businesses usually reduce total hours of employment with layoffs. Less growth of overall spending in the total economy will consequently mean fewer workers employed. In a materialist world, labor and capital incomes rise along with productivity and funds more consumer spending. In a post-materialist world, incomes rise along with productivity, but if spending remains stable, unspent incomes land in savings, unsold goods pile up, and real GDP declines bringing employment down with it.

Productivity growth is a good deal if we are all materialists and increase spending as our incomes rise, but not so good if we are post-materialists and direct added income flows entirely to savings. In the later instance, unemployment will chronically rise if nothing is done. Take heart, we can remedy the problem, although you might not like the fix if you are a small government conservative.

We have two obvious solutions to perpetually rising unemployment caused by a combination of labor productivity growth and stable consumption: (1) shift the responsibility for growth in macroeconomic demand from consumption to government, or (2) eliminate layoffs as the means to adjust total work hours downward and instead give everyone shorter hours and more leisure, what I would call the "European" solution. Let's begin with demand growth shifting.

You might be wondering why we don’t consider increased growth in private sector investment spending as part of the answer to consumer spending stagnation, but the rigidity of linkages between consumption and investment complicates this option. The essential task of business investment in a consumption-dominated economy is to fund capital goods, such as machines, computers, buildings, and other long-lived items, needed for the production of consumer consumer goods. Such business investment is undertaken for essentially two purposes: to replace used-up and obsolete capital goods with new; and to add to the economy's capacity to produce more stuff. Simply put, much of business investment depends in the first instance on the current size of the consumer goods sector, and in the second on the amount of its anticipated growth. Replacement investment hinges on the rate of capital goods wear and tear and obsolescence, which in turn will bear a relationship to the total capital stock required for current consumer goods production. New investment instead depends on the amount of growth in the consumer goods sector, and less growth in consumption will thus mean an absolute decline in investment spending. Simply put, investment spending is the tail that is wagged by the consumer spending elephant. We need to look elsewhere for a replacement growth engine.

All this really leaves is government for the task of offsetting stagnating growth in consumer spending. Let's put some numbers on consumption and government spending for a more concrete picture of how government spending can be altered to take care of a slowdown in consumer spending growth and put it all in per capita and real terms to eliminate population growth and inflation from complicating the story. 

From 2000 to 2013, U.S. inflation adjusted (real) GDP per capita grew from $44,600 to $49,900, a growth rate of a little less than 1% annually. At the same time, real per capita consumer spending grew at a little more than 1% per year, ending up at $33,900 in 2013, and real per capita government spending reached $9,200 after growing at an anemic .3% per year. The share of consumption in total GDP  currently equals 67% and the same number for government is 20%, meaning that consumption contributes more than three times as much as government (3.35 to be exact). In other words, to offset a reduction in the growth of consumer spending of 1%, the growth rate of government expenditures would need to increase from its current .3% to 3.65% or an addition of 3.35%, not a happy prospect for anyone who wants to see government shrink instead. In short, to keep the economy growing, government spending will need to expand enough to offset the declining consumption growth brought on by parsimonious post-materialists. 

Post-materialists will probably be perfectly happy with added government spending going to fund public goods that support shared public experiences and government actions that advance personal autonomy and environmental improvement. Pragmatic government action to solve problems of the day is a good thing in post-materialist eyes so long as basic self-expressive freedoms don't get trumped in the process. But a 3.65% growth rate in government spending on goods and services annually may not appeal to everyone, especially post-materialists with libertarian leanings. Over the very long haul, government would eventually become the dominant sector in the economy doubling in size about every twenty years. While post-materialists might be happy to see experience-, equity-, and environment-enhancing public expenditures per capita increased, they many not be too excited about government becoming the dominant force in the economy. We do have to remember we are considering an extreme case. Rather than all of us, perhaps as many as a fourth of us might be post-materialists in say 20 years with the rest of us remaining on a materialist path. This would cut back on the amount of government spending growth we would need to sustain full employment, but the principle would remain the same. Government would need to grow relatively to offset slower growth in consumption. 

As we will now see, a huge growth in government can be avoided by instead following what I call the  “European” solution. If we in the U.S. follow the recent European experience, we would use increased labor productivity to fund working hours reduction and expanded leisure rather than increases in consumer spending. The essence of the idea is to take advantage of greater productivity by keeping aggregate incomes stable and working fewer hours while still producing a fixed bundle of consumer goods for each of us. Sounds like nirvana to me, although I may like leisure more than some.

If we go back to the 1970s, the average weekly hours worked per employed person in the U.S. and Western Europe were roughly the same. By 2004, workers in Italy, France, and Germany put in 8, 7, and 6 hours less per week than those in the U.S. The primary reason for these lower average hours is an increase in legally mandated and negotiated vacation days, sick leave, and holidays in Europe, resulting in Europeans working substantially less than they did in 1970, while Americans continued putting in about the same amount of weekly hours. Europeans have taken some of their addition in hourly wages in recent decades in the form of leisure, but Americans have chosen to focus on increasing their take home pay instead.  Why this has happened is an interesting puzzle, but the feasibility of reducing hours in a modern affluent economies is what interests us here. If our consumption practices become increasingly post-materialist in this country, or anywhere else, than reducing average weekly hours is a simple and painless way to adjust an economy’s aggregate output to a lessened aggregate demand without killing off the employment goose that lays the economic golden egg. Instead of layoffs to adjust to demand growing more slowly than supply, we all cut out total hours of work to match our productivity increases. If we are more productive to the tune of a percent a year, then we cut our hours to the same tune.

Employers who resist cutting hours but instead cut people constitute the one barrier to this strategy. In the U.S. especially, employers find it more profitable to cut people instead of hours per person primarily because doing so can cut the fixed cost of health insurance associated with people. For Europeans, this is not an issue because health care or insurance is provided and paid for publicly outside of employment. The recently passed Affordable Health Care Act (Obama Care) moves the U.S. away from an employment-based health insurance system and eliminates the associated business cost-savings from cutting people. In the future employers will likely offer a cash health care benefit and encourage employees to purchase insurance on health care exchanges. Some predict the final result will be a single payer, Medicare-like health insurance system. A similar problem exists with employer-born employee training costs. By hiring fewer people, businesses avoid fixed job training costs much as they do for health insurance. Again, this problem largely goes away in Europe where more employment training is publicly funded than in the U.S. 

Cutting hours as opposed to people looks like a good strategy for adjusting to a post-materialist world. If the Dutch can do it, we can do it.