As the new year begins, the one enduring bright spot of the domestic economy is consumer spending. Over the past decade, consumer spending accounted for between 67 and 69% of our total economy or gross domestic product (GDP). Consumers are a large and stable share of total demand for goods and services.
However, continued high demand for consumer goods is not the same thing as economic growth. It is mistake to think that consumer spending is causing GDP growth, when consumer spending is simply a measure of demand.
Over the long term, economic growth is caused exclusively by productivity growth. That is simply how much more per worker the economy can produce or supply. Globally, how much we produce is identically equal to how much we can consume. However, inside each nation, we can sometimes consume more than we produce because other nations lend us money to do so.
To borrow money like this is an example of economic strength, which, by the way, leads to trade deficits. That is another story.
We should be mostly worried about long-term economic growth. I don’t wish to minimize the ill-effects of a recession, which can be very disruptive to many families. However, the short-run ups and downs we call the business cycle are forever with us. Our long-term prosperity is determined far more by long-term growth than short-term ups and downs. Stable household spending helps keep us on our long-term growth path, but does nothing directly to cause changes to long-term growth.
Consumer spending as a share of GDP does vary over time. In the 1960s it ranged from 61.8 to 59.6 percent of GDP. It has been rising fairly steadily since, plateauing at the current level for more than a decade. It has also grown far more stable, which indirectly helps reduce economic volatility. Why these changes occur are themselves and interesting side note to the economy.
American consumption patterns changed significantly over the past 90 years or so. In 1929, we spent about 70% of our family earnings on goods and only 30% on services. We were much poorer then, and so we allocated a larger share of spending to food, clothing, housing, transportation and the like. Movies, recreational activities, health and education were a smaller share of our family spending.
By the mid-1960s spending on services rose to half of household income, and today sits above 70%. This is true across most developed nations, and provides us a more stable levels of consumer spending. The reason for this is straightforward. In the face of rising fear of a recession, goods consumption can be delayed. We might delay the purchase of a TV, wait until next year to replace the car, or maybe hold off on that new RV purchase.
The consumption of services is harder to delay until good times return. So, families continue to pay medical, schooling, our cable TV bill, life insurance, and other items that cannot easily be deferred until the fears of a recession pass.
Demographics also play a role. Families with heads of household in their 50s and 60s spend very differently than families in their 20s and 30s, but the composition of a family are very important. Single people spend more on housing, but less on transportation or apparel than everyone else does. Married families with children spend much more on pension savings and insurance.
Family income also matters, with wealthy families increasing their spending on insurance and pensions, as well as food at home and housing. The poorest families spent a larger share on food at home and transportation services.
Strong consumer spending is a hopeful sign, because families take into account their personal economic conditions when making spending decisions. So, continued spending signals a widely held belief that the economy remains strong.
With unemployment rates low, and solid wage growth, there is little to suggest consumers will spend less in the coming year. This is good news, not because that spending will cause the economy to grow, but rather that sustained consumer spending makes it less likely that we’ll slip into a short-run economic downturn.
Michael J. Hicks is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University. He can be reached at email@example.com.