Cross posted at Brother Bob’s Blog
Welcome back, humble politician! Now that you understand the basics of how economics work on an individual (microeconomic) level, in this lesson you will learn how all of these choices roll up on a national level, or Macroeconomics. In the second economics class that you probably slept through during your pre-law school days the concept of GDP, or Gross Domestic Product was introduced. Put simply, GDP is the sum of all economic activity. You’ve no doubt seen a chart showing GDP growth before that looks something like this:
So what do all of these joined points represent? They are an aggregate (sum) of all of our measurable economic activity, made up of a few broad components that give you a formula that looks something like this:
Y = C + I + G + (X-M)
Y = GDP
C = Consumption. As the name implies, this is made up of anything that we consume, whether it is for food, clothing, entertainment, housing, etc.
I = Investment. Put simply, this is our collective savings. We invest (or as some of you like to refer to investment by private citizens, “speculate”) our money based on our goals for safety or higher returns. People who prefer safety will invest in stable, low return investments, such as Certificates of Deposit (CD’s). People who want a higher return will invest in riskier vehicles that expect higher returns, such as small cap stocks, starting their own business, or investment grade junk, such as bonds issued by the state of California.
G = Government Spending. This is of course your favorite piece of the economy! This represents everything that the government spends, whether it is on entitlements, military, infrastructure, (government) employee salaries and benefits, or payback for whatever interest groups helped to elect you.
X-M = eXports – Imports. Most macroeconomic models lump these two together, as they show how you add to the GDP all that we export for sale, and reduce it by how much we import from foreign countries. For our purposes I am going to use the algebraic methodology to back this out by subtracting them from both sides of the equation. This is too complex to go into great detail, but even though our import dollars go overseas, that item imported goes toward our own consumption. And likewise any item that we sell overseas that invests in America is actually consumed by someone outside of our GDP. There is a lot more to this, but Production Possibilities Curves and Comparative Advantage are concepts that are too advanced for you at this stage. But stick around – hopefully by the end of these lessons you will be ready to learn them too!
Back to our equation, if we back out the offsetting effects of imports and exports we get a simpler formula:
Y = C + I + G
To describe our overall economy in layman’s terms, think of your own household’s economy and look at your own paycheck. Before your direct deposit hits you see various federal, state, social security taxes, etc. taken out. Then of course you have to pay your property taxes, registration fees for your car, taxes on your investments, plus all of the other not quite as visible taxes, such as sales taxes and the higher prices you and your bretheren force everyone to pay as a result of regulations and trade barriers. This is the equivalent of the “G” portion of GDP.
Now that we’re past the portion of your income that you have to spend or face jail time, the next part is your household consumption. As I mentioned earlier this includes anything you’re spending to, well, consume right now. This is your food, clothing, whiskey, your car, your housing (although if you have a mortgage this could be more appropriately under investment or split between the two categories), going to the movies, books, vacations, etc.
What you have left is what you save or, invest. I’ve already listed some possible savings vehicles earlier and won’t recap them, but it is critical that you understand the distinction between government spending and investment. Contrary to what politicians holding the purse strings like to say, government spending is not a form of investment. An investment involves a choice being willingly made by an individual or organization looking to gain a return on the money that they are risking. Forcing tax payers to sink money into high speed rail lines that will go unused or wind mills that will produce expensive, inefficient energy are not examples of investment. There’s a reason that Joe Biden doesn’t invest his own money into rail lines. There’s a reason Al Gore doesn’t just invest his own money in green energy rather than bray for subsidies and regulatory mandates. It’s the same reason you don’t, and the same reason the rest of us don’t. These items have a proven track record of being bad investments, so please don’t tell us what a wonderful job you’re doing of managing our money when all that you’re really doing is doling out favors to the unions, green groups and various other members of the powerful anti-prosperity lobby that helped to get you elected.
Now that you see how government spending fits in and you remember where your money comes from, you can start to see the big picture. Any time we increase the G part of the equation, less is left for C and I. Even if you don’t take it away from us today, the American people are not as stupid as you think we are. We know that the money you borrow will eventually have to be paid back in future tax increases (or “revenue enhancements” as you like to call them) or through inflation, which will hurt the return on our investments and savings. Now you can start to see why the various government “stimulus” programs wound up having little effect and if anything, slowed our economy. Actually, this is a good point to break for today so we can resume with…
Chapter 4: You don’t create jobs – It’s time to get over FDR!