Investment Is the Engine of Our Economy

I was recently in a cab on the way to the airport. When the driver learned I worked in finance, he asked if we were in a recession still. "No," I responded. He then asked why a certain company was laying off thousands of workers. "Frankly, it's because the government's response to the downturn has made it worse."

I didn't get the chance to dive deeper into the subject, which was unfortunate. Though I don't know if he would have enjoyed it as much as I would.

So much of the focus has been on trying to drive consumer demand. Many people think, wrongly, that consumption is the engine of our economy. If we all just get out and buy more stuff, everything will all turn around. The economy will pick up and all will be well.

And we can all ride unicorns over rainbows to our new wealth.

This idea is fundamentally backwards. It isn't consumption, buying more stuff, that drives our economy. It is investment. It is productivity. It is the creation of new things.

It is easy to understand why we get this backward. It is ingrained in our thinking. It is how everyone looks at the economy. It is how all the talking heads explain it.

When we talk about GDP, we generally break it down into consumption and investment, and investment (buying capital like new machines to produce stuff) is always a much smaller portion than the consumption. But that isn't the reality of the economy, it is the flaw in our explanation.

Basically, in order to eliminate double counting from the data, we only look at "finished goods." So we don't take into account the production of all the goods. That phone in your pocket has a lot of parts to it. And you can be a lot of investment went into the production of all those parts. But only the finished phone is being counted in GDP. Which is fine, except when we want to talk about what really drives us forward.

"Well," you might say, "that is all well and good, but if we increase demand for products by buying more, won't that spur more production?"

Therein lies the fundamental problem with our thinking.

In order for us to consume anything, we must first produce something of value. You cannot simply go out and get a new smartphone. First, you must produce something for which you get paid. Once you've produced, you can then consume that new phone.

But our government policies have been completely focused on just the consumption. So in order to "spur demand," money is taken from someone, passed through multiple levels of government bureaucracy, and then a fraction of the original amount is delivered to the recipient. NOTHING HAS BEEN PRODUCED. Not only that, but actual value has been destroyed in the transfer. So while Person A now has a portion of Person B's money, the total value in the system is the same or less. So Person A can buy a phone, but Person B cannot.

In order to actually drive the economy forward, we must focus on production. We must focus on investment. We must focus on productivity and value. Taking money from B to give to A does nothing for us. But encouraging A and B to both produce will create real value for both. And with that added value, both can consume additional amounts.

How best to encourage productivity? Rather than the government forcibly taking money from Person B, we could allow Person B to keep more of what he makes. This could be accomplished through a reduced tax rate.

And what about Person A. If he is unemployed for example, continuing to pay him to not work or produce would seem counter productive. Rather, we could go back to a normal amount of unemployment benefits so that unemployment isn't a lifestyle, but rather a blip.

Ultimately, we must invest to move the economy along. We must encourage production as a means to increased consumption rather than the other way around.