Christmas is a time of relaxing with family, culinary excesses, and financial extravagance as friends and loved ones splurge on gifts.
Not known as the ‘silly season’ for nothing, Christmas is, of course, also the season of specious economic arguments. Exhortations for Australians to spend up big this time of year to stimulate the economy are a good example of the ‘broken window fallacy’, christened thus by French liberal economist Frederic Bastiat in the 19th century.
Bastiat pointed out that a broken window pane might bring cheer to the glazier, but the money spent on replacing the window is income lost to the tailor, the book shop, and ultimately every other business in the country.
Christmas is the same: extravagant spending at department stores, whether paid on credit or from disposable income, is ultimately a loss to other parts of the economy.
To the extent extra Christmas spending more than offsets belt-tightening in later months, it implies a reduction in saving. Less saving means less money for banks to lend to businesses and less money for consumers to spend at some point in the future.
A good economist should observe both what is seen – happy retailers – and what is not seen – the voiceless remainder of the economy. But this fallacy has infected a sizeable chunk of the economics profession, which is often caught trying to assuage the personal pain wrought by earthquakes and floods by pointing to their ‘beneficial’ impact on economic activity.
Some Keynesian economists still note how the Second World War was the ‘stimulus’ that ultimately ended the Great Depression.
But calls to spend around Christmas are even more damaging than the ‘broken window fallacy’ might suggest. One would naturally be as determined to get good value for money when replacing a window as when shopping for any other good or service.
Milton Friedman once famously spelt out the four ways of spending money, each having profoundly different implications for economic welfare. First, one can spend money on oneself, which is most likely to produce the best value given individuals will weigh up both the costs and benefits of their purchase.
The second and third ways are more inefficient, equally so. One can spend other people’s money on oneself. The ensuing spending is likely to be excessive but at least it will match up with the buyers’ preferences.
Christmas is the best example of the third way: spending one’s own money on others. That way, costs are contained but the quality of the purchases can leave a lot to be desired.
Shoppers buying for themselves are typically willing to pay more for their purchases than they actually pay, carefully concealing their maximum price. The difference between the former abstract amount and the actual invoice is known as ‘consumer surplus’ – the size of any ‘bargain’. A surplus is guaranteed because no-one would head to the checkout with a negative consumer surplus.
But receivers of gifts might attach less value to those gifts than their purchase price. One might call this difference a ‘consumer deficit’. As economic growth furnishes even poor people with every conceivable luxury, the aggregate ‘consumer deficit’ on Christmas day is likely to be growing.
So it turns out that far from being an economic boon, Christmas is also a festival of economic waste.
The fourth way is spending other people’s money on other people. The spender has the least incentive to watch over costs, and naturally can’t know the preferences of the recipients either.
The further the distance between the real payers, the decision-makers and the recipients, the more disastrous the economic consequences: a local charity is more likely to spend donations wisely than a distant parliament is likely to spend taxpayers’ money.
For all the waste and inefficiency of Christmas giving, it is still a vastly superior way of allocating resources than what occurs in government. The waste is hard to quantify because national income statistics treat a dollar of private spending the same as a dollar of public spending.
Government is not something that happens once a year, but every day of every year. It is therefore crucial that politicians and bureaucrats pay particular attention to the inherent value of their expenditures. The Labor government’s recklessly wasteful spending on school halls in the wake of the GFC – to list just one isolated but colourful example – should be a reminder that they still are not.
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