There has been a lot of discussion lately on the campaign trail, in the media, and on many blogs. However, there is a lot of confusion regarding production and consumption, and what they mean for standards of living. This post will be a little more wonkish that my typical ones, but I will do my best to keep it simple.
Let’s start by defining our terms:
Production is the goods/services an economic actor generates (eg labor, physical goods).
Consumption is the goods/services an economic actor uses (eg food, shelter).
Production and consumption are intertwined. Paraphrasing Say’s Law, one must produce in order to consume. In other words, why do we work? So we can put food on the table. So we can clothe ourselves and our families. Our consumption is fueled by our production.
Likewise, our production is fueled by someone else’s consumption. Say’s Law is often misinterpreted as “supply creates its own demand.” This is incorrect. Supply must move to satisfy some demand. If I were to produce drool-covered toothbrushes, no one would by them. Regardless of how many I produce, there would be no demand for them. That is because these items satisfy no demand. So, one must produce something of value, something that can be consumed, before s/he can consume him/herself.
Ultimately, one’s standard of living is lifted not by how much one produces, but by how much one consumes. Bringing this back to the drool-covered toothbrushes, could I increase my standard of living by increasing their production? Not likely. So, it is unlikely production in and of itself is what determines standard of living.
Now, imagine a family. Mom and Dad are, by far, the most productive members of the family. The kids, all elementary school and younger, are not much productive. However, are the kids’ standard of living lower than the parents? In fact no, they all share the same standard of living. Why? Because they all consume the same! We can reasonably conclude, therefore, that it is consumption that helps determine standard of living.
How does this work back into trade? On the campaign trail, Bernie Sanders, Donald Trump, and many others across all of time and space, have confused production and consumption and their roles on standards of living. They see exports (that is, production), as the measure and imports (that is, consumption) as the cost. That is the opposite of what is actually going on.
As I just said exports are production and imports are consumption. Exports are what we must give up in order to consume. If one expands exports and shrinks imports, then one is reducing standards of living! If a nation operates at a trade deficit (that is, imports are greater than exports), that is not necessarily a bad thing. When a foreign government subsidizes their products so they become cheaper for Americans, that is not a negative for Americans.
The important take-away here is that money is not wealth. Gold makes a poor shelter. Dollar bills make for bad dinners. These things contain value only in that they may be traded for goods/services that can be consumed.