In the current economic downturn, the rallying cry has been that we need to spend more to get the economy moving again. This flies in the face of the criticism of recent decades that Americans spend too much and don’t save enough. Which gives rise to the economic question: Is it better to spend or save? To answer this, we must look at what happens both when we spend and when we save.

When we spend money, we see what happens almost immediately. Most obvious, we get something for the money spent, usually some good or service. Of total consumer spending in the United States, we spend about 40 percent on goods and 60 percent on services. This is why it is said we are a service economy.

The goods and services we buy improve our quality of life in the present. Whether it’s a new television, computer, or automobile—or a massage, dinner out, or a movie—we experience the enjoyment of our purchase without delay. Often, current consumption is paid for with income we’ll earn in the future, through borrowing. The availability of credit allows us to get what we want, when we want it, and pay for it later. This poses a problem in that it necessarily means we’ll have less of our income for purchases in the future.

Spending and borrowing for current consumption creates jobs now. Every good and service must be provided by someone. As we’ve seen over the past couple of years, when we spend less on current consumption, jobs are lost. Even money spent on foreign goods and services creates jobs in the United States since those goods and services have to be imported, transported, stored, and sold, typically by U.S. workers.

But what happens when we save? At first glance, it appears we’re simply not spending money. And if we’re not spending, that means we don’t need all those workers to produce and deliver goods and services. But there’s more to it than that.

When we save, the money we would have spent isn’t simply taken out of circulation. Instead, it finds its way into bank accounts or savings instruments such as certificates of deposit. Banks and financial institutions then lend this money out. In this way, one person’s savings becomes another’s investment funds. Businesses borrow money from banks to finance capital goods, such as the construction of new buildings or the purchase of existing buildings, the purchase of new machinery or equipment, or other startup or expansion costs.

It all boils down to this: Income, regardless of whether it’s spent or saved, will be spent. Income that’s spent on current consumption creates jobs associated with producing and delivering current goods and services. Income that is saved is spent on capital goods—that is, goods that build our capacity to produce things in the future. Like consumer goods, the production of capital goods also creates jobs as machinery and factories are built and sold.

But if we shift spending from consumer to capital goods by increasing savings and reducing consumer spending, wouldn’t there be a diminished demand for the consumer goods and wouldn’t that remove the incentive for businesses to invest? To answer this, we must look again at the savers. Although the money saved ends up being spent on capital goods, that’s not the end of it. Savers, through the process of saving, build wealth they can draw upon in the future for consumption spending. By saving, we delay current consumption in favor of future consumption, and this generates future demand creating an incentive for business investment to meet that demand.

So the answer to the earlier question is that we must have a healthy mix of both spending and saving. But the argument that Americans would do better if we saved more and spent less on current consumption still holds true. The problem is the transition. We’ve been saving little and spending much for many decades, so our economy is structured to support current consumption spending. In the current downturn, it’s these jobs that are being lost as Americans are spending less and saving more. But if what we end up with is an economy that devotes more of its income to savings and investment and less to current consumption, this will lead to greater prosperity in the long run, the pains of the transition notwithstanding.                  

Robert Carreira, Ph.D. is director of the Center for Economic Research at Cochise College. If you have any questions on the economy, please contact the CER at (520) 515-5486 or by email at cer@cochise.edu. Check out the CER’s website at www.cochise.edu/cer.