Consumption vs. Investment: What drives the economy?

Knowing that we will be discussing Keynesian Economics any day now, I was pleased to read John Papola’s article “Think Consumption is the ‘Engine’ of our Economy? Think Again.” Known for creating the hilarious yet educational videos “Fear the Boom and Bust” and “Deck the Halls with Macro Follies,” Papola provides a simple explanation of the downfall of Keynesian Economics. The title of the article zooms in on his major point which is that consumption is not the driving force of the economy as Keynes assumed. Rather, it is the other piece of the GDP composition, investment, that leads to economic growth.What I like about Papola’s approach to bashing Keynesianism is that he is able to make economic theory real for readers. It is one thing to draw the models over and over again, but when you see that Keynesian Economics has failed in a real person’s own experience, it suddenly clicks. He tells the tale of a cloth diaper business which he and his wife started up and after devoting an entire year to designing and planning, Papola asserts: “Consumption didn’t create our output. Investment did.” Investment must take place in order to create the goods and services demanded for consumption. Quite simply, wealth must be accumulated before we can go out and spend it. I recommend this article as well as Papola’s videos to anyone who is looking for a simple and amusing breakdown of what is wrong with Keynesian Economics.

2 responses to “Consumption vs. Investment: What drives the economy?

  1. Obviously consumption does contribute to economic growth in a big way. I think that the author’s main point was that the economy would not be able to grow from consumption if it is not already supported by investment. A firm must have capital, human and physical, to produce and in order to keep producing, a firm must continuously replace capital as it depreciates. In the author’s opinion, the enormous contribution of consumption to the economy is only made possible by the growth coming from investment.

  2. How can you reconcile your argument here with the fact that consumption makes up 70% of total expenditure, while investment is only about 17%? In other words, how does consumption fit into the story?

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