Which Spending Comes First: Business Or Consumer?

There's a nice piece out today in the Wall Street Journal about whether or not businesses can pick up the slack created by the slowdown in consumer spending. The article concludes that such a hope might be a long shot. I hope it's wrong, and in a way, I think it could be.

There are two types of private sector groups who spend: consumers and businesses. When both of these groups spend, the economy benefits as GDP increases. As a result, a recovery for either would help the economy. Yet, consumers are saving instead of spending. I've also argued that consumers probably should be saving, or repaying debt, at a time like this. That leads me to agree with the WSJ when it says:

What the economy needs now is a business spending spree that will lead to a hiring boom and rising consumer incomes.

While both help the economy in the short-term, business and consumer spending are different in their long-term result. I believe that business spending is a lot better for the economy's ultimate growth. Although consumer spending might help businesses to make more profit, it only indirectly provides any growth. Business spending, however, directly benefits the future. That's why business spending is often also called investment. When businesses spend money on new facilities, machines or even labor, the economy will be better off in the long run, because those investments will provide future returns.

The two, of course, are intimately related. Many businesses cater to consumers. Business spending, for example, does not help Nike all that much, except for its professional sports sales. Even many companies that focus on manufacturing machinery or other products for businesses sometimes ultimately depend a lot on consumers to drive demand so that its potential customers need those business products.

In a perfect economy, these two types of spending both thrive off each other's success. In a bad economy, both suffer from the other's failure. In this case, consumer spending was the cause for business spending's woes. Since people stopped buying stuff, businesses were forced to stop buying stuff too and exhaust their excess inventories. But now that those inventories are finally getting low, could we see more business spending? The WSJ article seems pessimistic:

But after the 2001 recession, businesses accumulated cash, rather than spending it, because of the spending glut during the tech boom. They mightn't have much appetite for spending this time around, either.


They owned more than $4 trillion in equipment and software in the first quarter, about 29% of GDP, not far from the 30% that prevailed during the tech boom. Meanwhile, the nation's factories, utilities and mines in July ran at 68.5% of their production capacity, near a record low, giving them little reason to build out more capacity.

I understand the fear. On another level, it is a little bit of a chicken-egg problem. Does consumer spending have to begin to recover before business spending can? Or does business spending have to begin first, including hiring more workers, before consumers feel comfortable shopping again?

I'm really not sure, but I think both of these groups are going to need a fair amount of time before diving back into the market. That's why I believe U.S. growth is going to be quite slow in the recovery.

Consumers may find it more difficult to ramp up their spending first. As long as unemployment stays high, and people struggle to pay their bills, they won't have extra money to consume new products. Businesses, however, might be more comfortable tapping into their savings sooner, if they believe better times are ahead. That's why I'd expect business to lead the surge in spending. That surge, however, will likely be more of an anemic splash than a tidal wave.