Sunday, January 18, 2009

The Paradox of Thrift

Our Senior Minister Goh Chok Tong said the below during his Grassroot event on 6th Nov 08. His likely intention is to help boost confidence among Singaporeans to continue spending money in times of recession...

** Quote **
“If all of us go into a power save mode, then the economy will really go into a recession! This is what economists called the Paradox of Thrift. If you have sufficient savings and can afford to spend, you should continue to spend on life’s little pleasures.
“Take your family to the movies, shop, dine out at restaurants and hawker centres, go for your regular foot massage, indulge yourself at a spa, take a taxi, donate to charity and so on.
“This way, we keep the economy going. In fact, I would say when times are a little slow, you could get the best bargain.” - Senior Minister Goh Chok Tong.
** Unquote **

From Wikipedia, I found the following to explain Paradox of Thrift:

The paradox of thrift is a paradox of economics propounded by John Maynard Keynes. The paradox states that if everyone saves more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population. One can argue that if everyone saves, then there is a decrease in consumption which leads to a fall in aggregate demand and thus leads to a fall in economic growth.

In simpler words, it means that if we saves more money, the total revenues for companies will decline. This decrease in economic growth means fewer salary increases and perhaps downsizing. Eventually our total savings will have remained the same or even declined because of lower incomes and a weaker economy.

Another simple way to explain is by using an example of a leaking bucket.

* In a leaky bucket, an equilibrium level of water occurs when the leakage just equals the inflow of water.
* In the multiplier model, investment and government spending are inflows
* Taxes and expected saving are leakages
* When leakages increase and inflows remain constant, the level of water will be reduced.

When I read through the comments in "" website, many people are urging the government to give them money or cut tax like what Obama is expected to do in US. Obama articulated the opinion that "Only government can break the vicious cycles that are crippling our economy – where a lack of spending leads to lost jobs which leads to even less spending; where an inability to lend and borrow stops growth and leads to even less credit."

Many believe that in a financial crisis, the best way to get the economy moving is for the government to "prime the pump" by putting money in the hands of consumers.

The US goverment have to prime more money in because the people in US actually don't have much money. They are highly geared as compared to the Asians. They don't have much savings but still need to spend to keep the economy going because internal consumption take up probably 60% of their economy. If all spending stops, more companies will go bankrupt and more unemployment to come.

But of course, priming money doesn't means giving out money all the time, it can be in the form of tax cut or increasing government expenditure and investments, etc. All these will increase the already ballooning deficit faced by the US Treasury. Nobody knows if Obama's plan will works. Just pray hard that it will or else the global economy will continue to stay down for a long time to come.

As for the consumerism story in Singapore, I think that the "Paradox of Thrift" doesn't apply much here because we are largely a service and manufacturing base compared to the US. The challenge of our government to ensure Singapore stay competitive and as many Singaporeans retain their jobs for as long as possible before the economy turnaround.

Many companies get their projects and contracts secured during times of good economy and managed to save for rainy days. They probably hold retrenchment plans till the last of the project are completed. If the recession stay longer than expected and new projects are not secured, Singapore will be in deep trouble.

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