In our previous article, we discussed about how crucial spending is to the economy. We were talking like our life depends on spending, and that is still very true actually. Though a natural law it seems, there is more to the art of spending than how it looks at the face value. Remember, my previous article offers no false statement, but correctness/truth does not translate into completeness.
John Maynard Keynes, the world renown economist, might not have invented the so-called “Paradox of thrift”, but he did re-introduce it to the world and popularized it . To recap, pretty much what he said is that being thrifty is good for yourself at first, but bad for the whole economy and ultimately bad for you because if everyone is being too economical, less money (wealth) will be circulated, and in the end, we will all have less of everything. The more you save, the less you spend, the less the aggregate income for the economy. That is the rationale behind this simple economic concept.
Moreover, we have made it very clear that while broken window does not make you very thrilled, the money does not go to waste (no deadweight) because the repairman will get paid from you. Good for him, and this is how the economy runs. Your expense will be another’s earning. Simple and beautiful.
In a nutshell, spending = earning.
However! However, spending is definitely not the only option. You see, we have talked about how spending creates income (and vice versa), but one thing was left out in our previous article. What is it? It’s “saving”!
This piggy bank definitely keeps your money away from your urge to spend, but it does not generate interest like banks do. So, better go open a saving account now and keep you saving there, like the mysterious man in the suit above did!
Image source: http://s3.amazonaws.com/rapgenius/need-bank-account-1.jpg
Before all else, the very basic equation to be noted here is:
Y = C + S; where Y stands for Income, C for Consumption, S for Saving.
Spending is, in essence, consumption because you spend to consume various products and services. The equation simply describes the split of income of a single individual or economy into two distinct parts:
1. Consumption by spending on goods and services (i.e. spending)
2. Saving (whatever is left of the income after a portion has been used for consumption)
A part of economics is based on a very simple core assumption that people do not spend all that they earn. In fact, for the majority of the population, this is very true. People who think about the FUTURE, save. They save for various purposes. What are those purposes?
Assuming that, being more mature, you stop going to eat at expensive restaurants, and you start learning how to cook and eat more home-cooked meal. Yes, being a little bit thrifty. Now that you decide to act more like an old person (or maybe you are indeed one), the restaurants you used to patronize will lose one of their customers, and thus, a tiny bit of the revenue. So, is that bad for the economy if more people become like you? Not really.
In fact, there are several ways you can employ your saving:
You can turn the saving accmulated over time into a either a direct loan or indirect loan (via banks) to earn interest
You can invest the saving on various forms of assets like stocks and bonds to obtain return in the form of interest or capital gain (profit from sale of those assets at a later point in time after having made the purchase)
You can use the saving (assuming it is large enough) to start a business of your own
You can also just keep the saving under your pillow (or even better, in a bank saving account to earn interest at the same time) in case of emergency
If you have saved enough, you can use it to buy yourself something of great value to you like a new laptop that can offer greater satisfaction and productivity
If you are one of those who value philanthropy, you can share your saving with friends (not going to happen, I guess) or donate it to good causes like organizations working to combat cancer, HIV, or provide aid relief to victims of natural disaster.
What do the above options represent? They represent the alternatives or the “opportunity costs” of spending money on eating out at expensive restaurants (Just a side note, opportunity cost is simply what is given up in order to pursue something).
These alternatives come with their own short-term and long-term benefits, not just to you, but to the society and the economy at large. Here are some that I can think of right on the spot:
– Savings that have been turned into loans, either directly by you or indirectly by the bank in which you deposit your saving, will have positive impact on the economy. Why? Because the loans made can allow someone else to buy a new house, to start up new businesses, to expand their existing businesses (thus employing more people and buying (spending on) more capital), pursue higher education, etc. All of these greatly boost the economy in the long-run.
– Investing your saving in the stock market, especially in IPO, can help provide interest-free (assuming no dividend paid out) financing to businesses. As for investing in government bonds, you can help providing low-interest loan that can help finance various public services.
– Starting your own business can have various positives on your immediate surroundings, on the society, and on you, yourself (if you business is successful). First, it provides jobs for people. Second, businesses pay taxes to the government, to the country. Third, business helps its vicinity by attracting more people and more businesses into that same location. Just to name a few.
– Keeping your saving as emergency fund is never a bad idea either because who knows what the future lies?
– Saving to buy something that can raise your living and work quality like a brand new laptop is great because it is cost-effective. With a new laptop, you might be able to work faster and more comfortably, while being more conveniently connected to your family if you live far away from them. Just think about all the pros a new laptop can grant you.
– Donation for humanitarian purpose is also a good thing because it helps channel fund from the haves to the have-nots. It helps alleviate impacts of various unexpected disasters like tsunami and earthquake. It helps restore stability to the economy after having suffered and having its foundation shaken. Furthermore, in the era of globalization, everyone is connected via vast and complex network of commodity and financial markets. Countries become more inter-dependent. When things are more closely tied within a network, impacts from both fortune and disaster of a certain country, if powerful enough, can be felt across the globe. This implies that saving the others can be the same as saving yourself. Why? Just imagine a country that produces agricultural products like wheat being afflicted by earthquake. That would definitely raise wheat price, and thus, many other products like bread that uses wheat as its main ingredient. You would definitely feel the impact; that is why donation sometimes isn’t just about saving the others.
When Japan was hit by a major earthquake back in 2011, the effects rippled across the globe causing stock price to drop, oil price to fall, and price, especially that of computer chips, to jump due to the fact that Japan is a major supplier of memory chips used in portable electronics. At time like this, external aids play a crucial role in speeding up the recovery process.
For more info: http://www.pennlive.com/midstate/index.ssf/2011/03/japan_earthquake_shakes_world.html
Image source: http://knowledge.allianz.com/environment/natural_disasters/?1416/disaster-relief-myth-reality
So, I guess spending is not the only option and definitely not always the best option. But have you noticed anything strange yet? Let me point it out for you.
You see, the equation, as we mentioned, is Y = C + S.
Since Y is income, that means that for consumption (C) to happen and saving (S) to be employed in the various ways as we have discussed, you would first need to earn income (Y). Where does your income come from??? Of course, without doubt, other people’s spendings (their consumption, C). You see that? See how they are all connected?
For you to having the ability to save and use your savings on the many possibilities you like to imagine, you would first need someone to spend so that the resource can be channeled to you. Thus, while reckless spending (spending-spree) is not promoted nor recommended by Economind, we do encourage you to establish a good spending habit by taking into consideration the various options as displayed above. Why? Because a good spending, one of justifiable amount, is a plus for you and the whole economy. This is a much more sustainable way of managing your life and the economy in the long run.
While this is just another slight glimpse into economics, it is an important groundwork for much of our discussion in the future. It is an easy-to-understand concept that you have probably known and understood even before reading this article, but it must never be underestimated as it is a building block into something bigger, better, much more intriguing, to which we are approaching.