29 April 2012

Consumer Demand is Not the Whole Picture

See if you can spot what’s missing:

Businesses aren’t investing in the United States because of a lack of consumer demand, International Paper CEO John Faraci said Friday.
“I think this was all about consumer spending and demand. You know, the problem we have is there’s inadequate demand to create jobs. We know how to respond when there is demand,” he said on CNBC’s “The Kudlow Report.”
The U.S. Commerce Department estimated that gross domestic product expanded at a 2.2 percent annual rate in the first quarter, falling short of analysts’ expectations it would grow 2.5 percent and slowing down from the fourth quarter’s 3-percent rate.

The more correct way of saying this is that there is a lack of consumer demand for products at profitable prices.  There is plenty of demand for cheap goods (for example, imagine what would happen to iPad sales if the price dropped to $150 each).  The problem is that cheap goods often have very thin profit margins.

Also overlooked in this admittedly shallow Keynesian market analysis is that purchasing power has declined.  It’s not that demand has disappeared or necessarily reduced (who doesn’t want stuff?); it’s that people don’t have the ability to act on their demand.  Put plainly, people don’t have money, regardless of whether we’re talking cash or credit.

Thus, saying that demand has declined is a rather shallow way of addressing the problem and thus begs a shallow solution (quantitative easing, e.g.).  The deeper issue is that people’s real income has declined, alongside their ability or willingness to use credit to purchase things.  Therefore, the proper solution is not a short-term stimulation of demand, but rather an attempt to fix the structural flaws that have caused a decline in real income.  The causes for such a decline are various:  free labor, inflation, free trade, and so on.  Fixing these things won’t be easy—in fact, they’ll be quite painful in the short-term—but they will lead to a long-term fix.  Unlike a stimulus.

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