YOU DECIDE: Are consumers still calling the shots?

Date posted: August 19, 2011

Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

You Decide: Are consumers still calling the shots?

Much of the recent economic news has not been good. Unemployment remains above 9 percent, with many forecasts saying it will stay elevated. Loans are difficult to get. Consumer confidence is low, and home sales remain weak. Then there’s the wild ride — both up and down — investors have had on the stock market.

There’s no shortage of reasons given for the relatively bad economy. Many fingers have been pointed at the federal government, for either spending too much or too little or for having taxes too high or too low! Corporations have been blamed for having money but not spending it on workers. And borrowers are upset at lenders for increasing the standards necessary to obtain loans.

While good arguments can be made for all these reasons, there’s another force in the economy that can’t be overlooked — you and me as consumers. Consumers dominate the economy. In any year, spending by consumers accounts for about 70 percent of all economic activity, more than twice as much as spending by businesses and government combined.

Therefore, as consumers go, so goes the economy. Today, the big problem in the economy is that we consumers haven’t been going very well.

Some new analysis by the Federal Reserve Bank of San Francisco clearly illustrates the problem. Consumer spending per person, after adjusting for inflation, is still below pre-recessionary levels. Maybe more important, consumer spending per person is almost 10 percent lower than it would have been if pre-recessionary trends had continued.

The lack of consumer spending is one of the main reasons businesses have been reluctant to expand and hire. Businesses are always looking ahead. Prior to the recession, most businesses would have expected a continuing increase in consumer spending based on past trends. Production and hiring plans would be based on these forecasts.

But now businesses are adjusting to lower consumer spending than they previously had predicted. Past expansion plans have been thrown out and replaced with more modest futures. Often, new plans have resulted in downsizing.

Yet this analysis raises still another question; what’s behind the drop in consumer spending? One answer certainly could be the job situation. Consumers need jobs to provide them with the income to fuel their spending. With unemployment a continuing problem, it’s easy to conclude the lack of jobs is the main issue holding back consumer spending.

However, an alternative argument is that unemployment is a symptom and not a cause. The lack of jobs stems from the lack of spending. A vicious circle has been established, where low spending has led to fewer jobs, which in turn generates even lower spending and more job cuts. But what was the spark — or shock — that began the circle?

Many economists see an answer in our wealth, or lack thereof! Wealth is different than income. Income is what a person earns on a periodic basis; for example, from a job or pension. In contrast, wealth is the difference between the value of a person’s assets (or investments) and their liabilities (or debt).

What is important to realize is that wealth, like income, also drives spending. Research shows that every dollar change in wealth can alter spending by between 5 and 7 cents. So if consumer wealth goes up, so too will consumer spending. And if consumer wealth falls, consumer spending will also drop.

The problem is that the recession devastated the asset part of our wealth equation. At the height of the recession, consumers collectively saw the value of their assets drop $16 trillion, with two-thirds of the drop from financial assets and one-third from property (real estate) assets. This was a 20 percent hit to our assets.

While our financial assets have recovered about half of their losses, our property assets, mainly the value of homes, haven’t. This is unlike recent recoveries from recessions, when the home-buying market was a big boost to the economic rebound.

The point is that the loss of wealth and the continued weakness in the housing market are big factors behind the slow economy. Home equity was long considered a stable source of value for consumers; now it isn’t. Lower home equity has translated to less consumer spending. Plus, many small businesses traditionally have been started by using equity in the entrepreneur’s home. Now that equity isn’t there.

Consumers are still rulers of the economy, but our reign has been loosened with the recession. When will we reclaim our power? You decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The College of Agriculture and Life Sciences communications unit provides his You Decide column every two weeks. Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective/

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