“Someone is sitting under a tree today because
someone planted a seed a long time ago.”
To increase the productive capacity of the economy and allow us more choices, requires that we refrain from consuming all resources now and invest for the future.
Resources- land, labour, capital and enterprise – are dedicated to future production. Turning iron ore into machinery rather than cars, educating the innovators of tomorrow, and incentivising the use of new technology, are some examples of ways as a nation we invest in the future.
Some decisions or allocation of budget resources may pay dividends quickly; others take time, such as grants to research facilities or revising the school curriculum to include coding in the kindergarten school curriculum!
The funds available to increase the productive capacity of the economy (via investment) primarily come from the pool of national savings contributed by both by the private sector (households) and the public sector (government) via the financial sector.
Remember, to have more options and less scarcity; we need to make the economic ‘pie’ grow or, shift the production possibility curve out to the right.
Likewise for us households!
Another way of thinking about the size of the economy is via the simple circular flow of income model that looks at injections into the economy vs the leakages as a result of the activity of the five sectors – households, firms, government, financial and overseas.
Think of it as a large above ground swimming pool. The more water that is pumped in (injections), the higher the level of water in the pool and more people can get in and get wet. Spring a leak and the water level falls meaning some swimmers need to get out. (= unemployment)
Injections are consumption expenditure (C), investment expenditure (I), government expenditure (G) and the sale of exports (X).
Leakages are saving (S), tax (T) and imports (M)
National Income (Y) or the size of the economic ‘pie’, or the level of the water in the pool is equal to:
Y = C + I + G + (X-M)
If injections are > leakages, the economy will grow.
If leakages are > injections, the economy will contract.
Consumption is the most significant contributor to aggregate (total) demand in the economy. Maintaining consistent consumption is vital to keep people employed.
Regulating the level of consumption in the economy is one of the primary responsibilities and targets of macroeconomic management. Variations in consumption, both increases (in times of prosperity and strong business and consumer confidence) and decreases when the opposite conditions prevail, has significant impacts on the level of income, output, and employment in the economy.
Via the multiplier effect, any change in consumption has a ripple effect throughout the economy.
For example, currently, the federal government is providing a stimulus package to support consumption and businesses in the wake of the exogenous shock to our economy that has necessitated social distancing to combat COVID-19.
One of the cash injections will be in the form of two $750 payments to Pensioners. Why? Because most pensioners are living on minimum incomes and so they are extremely likely to need to spend, rather than save the bonus payment.
Their marginal propensity to consume (MPC) is high.
The MPC is a measure of how likely a recipient of funds is to spend an extra (or marginal) dollar they receive.
If the MPC = 0.8 recipients will spend 80 cents and save 20 cents
The formula for the simple expenditure multiplier k = 1/1-MPC in this example 1/1- 0.8 = 5
A $10 million injection into the economy, in this case, will result in a much more substantial $50 million stimulus to the economy.
The MPC for pensioners is probably more than 0.8, resulting in an even more powerful stimulus to the economy.
Of course, this simple example assumes the recipients of their spending will have the same MPC. It may be higher or lower; nonetheless, the concept is evident. A carefully targeted injection into the economy will have a reasonably predictable compounded effect on consumption, incomes and employment.
An understanding of the power of
is fundamental to understand the significance
of the housing market
and why governments
to invest in bricks and mortar.
“Home Building Packs a Punch in Job Creation Stakes”
A new report from the National Housing Finance and Investment Corporation reinforces the view that “the residential construction sector punches well above its weight as an economic multiplier” and “understanding how residential construction activity may affect jobs and flow through to the broader economy is increasingly important… The Urban Developer June 19, 2020
But what if in times of uncertainty households save instead of spending?
All is not lost, nor is the stimulus ineffective.
They provide funds via financial institutions for firms to invest and increase their productive capacity. Provided you don’t stash your savings under the bed, (a leakage from the system) you are making it possible for firms to borrow and invest and build the capacity of the economy.
That constitutes a passive investment in the economy and our future collective welfare, but
You can also do the same,
individually and proactively!
We can invest in our own and our family’s future by devoting some of our resources (time, income, assets, efforts and skill) to education and training to improve our earning capacity or saving to directly and deliberately invest in creating future wealth.