With more signs that the economy is now in a recession, there have been suggestions for a fiscal stimulus (Krugman), or even possibly to encourage more consumption. It has been pointed out that the drop in auto sales is extremely worrying since households are now cutting back on auto spending. Instead of changing cars every 3 years (or whatever the number is supposed to be), they are now holding on longer to their vehicle. So should we encourage consumption to get out of a recession?
Before the crisis, economists were pointing to the large global economic imbalance and how this might be addressed by a depreciation in the dollar which would in turn lower the current account deficit and possibly consumption or investment. (For current research on current account sustainability, see here.)
Those who support increasing consumption point to the Paradox of Thrift. Quoting Interfluidity:
It is true that one person's spending is another person's income. But it does not follow that an increase in saving translates to a decrease in aggregate income. There are two kinds of spending, consumption and investment. Laying a subway line adds to somebody's income as surely as buying a Ferrari does. Ordinarily, nearly all savings are actually spent on investment goods, and there is no "paradox of thrift". What is "saved" is really spent on current production of future capacity, and there are plenty of paychecks to go around. There is no "fallacy of composition": individually and in aggregate, today's thrift lays the groundwork for tomorrow's abundant consumption. ... However, for this to work out, two things must be true: Today's savings must be invested in projects that will actually generate future wealth, and savers must believe they will retain a stake in the increased wealth commensurate with the size and wisdom of their investments. ... Encouraging people to go shopping in order to help the economy is not "second best" policy. It's a desperate last resort. We're not at a point where there's so little economic activity that we can't foresee future wants. We're at a point where people are beginning to shift from investment to storage because of a well-deserved loss of confidence in the financial system. Encouraging consumption now is nihilistic.
So perhaps we shouldn't encourage consumption.
Unfortunately, since we are not spending on cars, carmakers need someone to spend something on them, and that someone is going to be Uncle Sam. From the WSJ on bailing out Detroit:
In 1993, the legendary economist Michael Jensen gave his presidential address to the American Finance Association. Mr. Jensen's presentation included a ranking of which U.S. companies had made the most money-losing investments during the decade of the 1980s. The top two companies on his list were General Motors and Ford, which between them had destroyed $110 billion in capital between 1980 and 1990, according to Mr. Jensen's calculations. ...
Over the past decade, the capital destruction by GM has been breathtaking, on a greater scale than documented by Mr. Jensen for the 1980s. GM has invested $310 billion in its business between 1998 and 2007. The total depreciation of GM's physical plant during this period was $128 billion, meaning that a net $182 billion of society's capital has been pumped into GM over the past decade -- a waste of about $1.5 billion per month of national savings. The story at Ford has not been as adverse but is still disheartening, as Ford has invested $155 billion and consumed $8 billion net of depreciation since 1998.
As a society, we have very little to show for this $465 billion. At the end of 1998, GM's market capitalization was $46 billion and Ford's was $71 billion. Today both firms have negligible value, with share prices in the low single digits. Both are facing imminent bankruptcy and delisting from the major stock exchanges. Along with management, the companies' unions and even their regulators in Washington may have their own culpability, a topic that merits its own separate discussion. Yet one can only imagine how the $465 billion could have been used better -- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen.
So it turns out that while we car makers cannot encourage consumers to buy their cars, they can just as well persuade the government to spend on them. While the latter does not increase their sales, the carmakers hope that it will increase their future productivity. But as the WSJ article points out, they do not have a good track record in investment. Is the deadweight loss of a government bailout larger than the deadweight loss of giving each U.S. consumer a $5,000 check to spend on a new car? Note: Population of the U.S. is approximately 305,700,000.