Does living frugally hurt the economy?

by Philip Brewer on 10 May 2008 22 comments

When I advocate for frugal living, people sometimes ask, "What if everybody lived like that?  Wouldn't it hurt the economy?"  My natural inclination toward frugal living may color my opinion, but I don't think so.  I think mass frugality would be good for the economy.

It's a valid concern, rooted in the way recessions and depressions start.  Some recessions are business-led, with businesses cutting back first and consumers following because their paychecks are smaller and they can see that their jobs are at risk.  Others are consumer-led, with consumers cutting back first and businesses responding to falling sales with layoffs.  Either one, of course, leads directly to the other, and there's no automatic mechanism to stop the downward cycle.

So, the question is:  If everyone suddenly decided to be more frugal, would that look like a consumer-led recession, with  falling sales leading to layoffs, and layoffs leading to cash-strapped consumers choosing to be even more frugal?

It's a question that's hard to answer.  If everyone were a bit more frugal, yes there probably would be a bit less total economic activity.  (Xin Lu lays out this case in her post from a few months ago, What if everyone suddenly became frugal.)  I think, though, that the exact result depends a great deal on the economic situation at the moment the change takes place.  It's kind of like hesitating before giving someone an aspirin:  Won't it cause his temperature to fall?  Well, if he's got a fever, yes it probably will.  Otherwise, probably not.  In much the same way, if the economy is overheated, then a shift to frugality will probably slow it down.  If the economy is underperforming, I don't think a shift toward frugality will make a big difference--if everyone is already reduced to focusing on just the necessities, becoming more frugal isn't much of a change.

So, the downsides may be real, but I think they're small.  On the other hand, if everyone is more frugal, the upsides are potentially huge.  A lot of the harm in a recession comes from fear.  The people who are unemployed have less money to spend, but even people with jobs start to cut back, simply because they're nervous.  Frugal people are less vulnerable to this.  They have less debt, more savings, and more room in the budget to handle a drop in income.  They don't panic when their neighbor loses his job--because they don't need to.  The result is that the frugal household is more stable.  And a community of stable households is a more stable community.

Any change in consumer's tastes--deciding that they want less of anything, whether it's VHS tapes, camera film, or incandescent light bulbs--is hard on the businesses that produce those things.  But it doesn't kick off a downward spiral, because there's a natural point of stability:  the point where the consumers are buying whatever it is they now want.  The shift to more frugal consumption patterns would be like a change in tastes, not like the beginning of a recession.

So, I feel comfortable advocating frugality.  We may lose a bit of economic activity--but what we lose is worth losing.  What we gain is more secure households and a more sustainable economy.  It seems like a win to me.

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Guest's picture
Guest

I agree with you 100%. If people had consumed less and saved more we would not be in the financial mess we are in right now. Unfortunately there are now many people who have been forced into frugal living in order to pay off debt and keep a roof over their heads.

Guest's picture

There is a bit of faulty logic in the thought that spending is always good for the economy. A certain amount of money should be saved so that it can be invested in new projects.

I'm a little rusty on my economics, but take a look at the wikipedia entry for the Golden Rule Savings Rate. (sorry not sure how to link)

Think about the name of the economic slowdown we're currently facing. "The Credit Crunch" (or something along that line) I imagine if people were a little more frugal, saved a little more, and were not so dependent on credit to finance their spending our country could be in a lot better situation than it's in.

Guest's picture
Curt

If everyone suddenly becomes frugal ... it will have a sudden impact on the economy. I agree with you, that the more frugal a community is the more stable they can manage a recession. But, its the suddenlyness that is dangerous, which is why the politicians are telling us that everything is ok. The consumer price index has already declined for 4 months. They don't want a panic.

Another danger is high inflation, like we are seeing with food prices, because it can create a panic.

Guest's picture
Lindsey

I agree that a sudden increase in mass frugality will hurt the economy. I think that it did happen and that is one reason the recession continues to worsen. I think that politicians did scare Americans into consuming less which in turn hurts the stock market and businesses. The politicians specifically scared Americans during the presidential election campaign by Barack Obama and others calling this recession an economic CRISIS not seen since the Great Depression. Even after Barack Obama got elected, he continued to scare Americans about the economy.

I think that Obama’s lies about his stimulus plan working and about the economy’s improvement will just hurt him in the long run by ruining even more Americans’ trust in him. This is, in my opinion, a good thing since I’m not fond of Obama’s excessive spending of money we don’t have and his other policies and hopefully he will not be reelected.

I agree that frugality is better for America as a whole if it is the norm. I agree that when a recession hits it would not be as bad if people had money saved and lived within their means. But, if you are wealthy, please spend, spend, spend —it will help the economy to spend and consume within your means.

Guest's picture
Guest

You're exactly right. According to the IS-LM model decrease in consumption leads to a decrease in demand, which in turn leads to a decrease in output. It's a big simplification of the actual economy, but what it boils down to is that the economy will readjust to a different, yet still stable, equilibrium with a lower level of output.

I'm always a little bit amused by how that decrease in output gets to people, especially because in biology we call rapid, uncontrolled growth "cancer", and we do our best to combat it. :)

Guest's picture

Yes, we are a consumption based economy and society, and being frugal would "seemingly" hurt the economy. But think again, think different, think macro. Frugality would actually benefit the economy.

If everyone became frugal:

Our trade defecit would go down.
The dollar would go up.
Interest rates would go down.
Inflation would go down.

Much of what we consume is imported, if we consume less, we import less. When we import less, than we export, the trade defecit declines and the dollar rises.

If we consume less, we conserve more, we end up saving money. When we save money, the treasury has to borrow less money, and interest rates go down.

When we are frugal and consume less, prices stop rising, and inflation goes down.

Frugality is good for you and the economy!

Guest's picture

I always thought the economic stimulus checks should be used to pay down debt and boost savings. In this way, the checks would be used frugally instead of providing a short-term boost to the spending economy.

Philip Brewer's picture

Thanks for all the good comments.

Maybe in some other blog my post would have produced some controversy.  Here in Wise Bread, not so much.

There may be some hazard if everyone suddenly decided to live frugally, all at the same time--the drop in economic activity would look a lot like the start of a recession--but that doesn't seem very likely.  Much more likely at the moment, is the combination of a looming recession together with a credit crunch forcing more and more people to live frugally whether they want to or not.

I hate the suffering that poverty causes, but the minor squeeze facing ordinary middle class folks seems more like a good thing to me.  I'm thrilled at the idea of people combining trips to save a little money on fuel, buying cheaper cuts of meat (or less meat altogether), and getting books out of the library rather than buying yet another video game.

What makes me sad are people having to choose between filling a prescription or putting food on the table, or between keeping the heat turned on and new shoes when the kid outgrows the old ones.  If what we have turns out to be a recession, there'll be plenty of that.  Choosing to be frugal without waiting for circumstances force our hand can help.

Guest's picture
AndyS

A case in point is Japan in the early 90's after the collapse of their financial system. Saving rates went up significantly as people moved to cash and reduced their spending. 15 years later the country is still recovering. While this is more than just due to frugality, it has been shown time and again that consumers are the drivers behind economies. If they start cutting back en masse, the whole economy and country will suffer. Too long to go into it here, but what makes discretionary consumer spending so powerful is the multiplier effect, where every $1 spent ends up a $6-$7 effect on the economy.

Andy.

Guest's picture

i agree. especially the US economy.

1. we consume 25% of the world's fuel
2. we consume 20% of the world's other natural resources.
3. we import stuff from almost every country in the world.

if we were to cut down our spending, it would cause an international economic recession.

Guest's picture
Guest

Random thoughts. Would voluntary frugality make us more of a cash/barter society? Bankruptcy would decrease. That impacts us all. Financial problems have major impact on marriages. Would less stress save more marriages? Divorce lawyers would have to diversify. A Wisebread article recently adressed what "poor" looks like in this country--cable TV, own home, etc. What happens if we actually stop being consumption driven? Would we become more content with less or different? You know, the basics, food, clothing, shelter. Would we be willing to wait for something instead feel we're entitled to immediate gratification? Would kids stop bugging their folks for cell phones? Would robberies go down? Would people drive 55 or under? Would we need fewer cops? Would individual creativity and problem solving be pushed in schools instead of the group learning, techno saavy model used now. The trade deficit would decrease. Toy stores would be hard hit. Fast food restaurants, rent-to-own places would go under. Less shipping containers rusting on the docks. We might start using our farmland again as farmland instead of turning it into mega developments. We'd put less stuff in landfills. Construction people would learn to fix existing buildings instead of ripping down old and building new. Would the government eventually see the need to live within their means too? Or would the largeness of the machine have to find work for government employees? Would there be a shift to improve public transportation, roads, reinstitute WPA type projects or would the bread and circuses model reign? Would our houses become smaller and more efficient? Would we go to alternative fuels? Would our work ethic improve? Would we start making our own stuff like rag rugs and clothes?

The driving force in voluntary frugality is contentment. Forced frugality is another matter. Both have an immense ripple effect on society and on the economy but it may not be a bad thing if taken as an opportunity instead of an obstacle.

Guest's picture
Sean

When people ask, "Wouldn't it hurt the economy?" ...I think there is a tendency to think of "The Economy" as an end goal, not a means to other goals. To get to the heart of the matter, we need to refine the original question.

i.e., "What are the best measures of a healthy economy?"

Guest's picture
Kelja

Frugality would kill the modern economy.

Simple, really, it comes down to jobs. Less spending equates to fewer jobs. (Come to think of it, people were damn frugal during the great depression.) Philosophically, you might not believe in conspicuous consumption, but it is what drives the world's economy.

Individually, being frugal does make sense. Globally it doesn't. But not to worry, man is innately a consumer. It's not only his nature, but the nature of nature. In times of plenty, the impulse of all living creatures is to eat and store more of whatever is valuable. This makes sense, because bad times eventually come.

As for me, I'm not very materialistic (comparatively speaking) but I still see the world as it is, not as I wish it to be. To choose to be frugal is only a choice when you live in a rich society. Otherwise, it's not a choice.

Guest's picture
Scott

Many people have compared the current economic situation ("Credit Crunch", "Housing Bubble", etc) to the Great Depression. One of the issues heavily debated during the Depression was whether the U.S. government should provide assistance to people living in the Dust Bowl. Providing aid might encourage people to continue living in an area that, at the time, was seen as worthless. Instead, people should be given the incentive to move elsewhere, regardless of the cost in human suffering. Fortunately, changes in farming techniques and public works programs from the New Deal helped put the country and the Dust Bowl region back on track. But it required people to change their way of life in dramatic ways.

The tilling of the earth in the Dust Bowl was driven by loose credit lending that enabled farmers to purchase new farming machinery that destroyed the Great Plain grasslands at a staggering rate. This led to erosion of the soil, which caused widespread destruction of crops throughout the region.

Loose credit lending is destructive. People are seemingly incapable of knowing how much is too much. It happened in the Great Depression, and it is happening now with the Credit Crunch (I really dislike this term). There must be some pain felt by those who were over-extended. I think that the generation who experienced the Great Depression will always remember the costs of excess. Perhaps this is the opportunity for today's youth to learn the true price of credit.

I think that being frugal in good- and bad-times makes for a better situation for the individual, but I belive it's unrealistic to expect this from the average American adult. It seems to be in our nature to indulge in excess, and credit-lenders are more than happy satisfy that urge when the reward is high.

Guest's picture
Poorboy

Current economic thinking is that consumption is good for the economy. So going along with this it would imply that people who buy consumer goods on credit are good for the economy.

The big problem I have with this thinking is that it ignores the costs of servicing debt. I wonder whether someone who buys a massive TV screen with their credit card feels wealthier. Wouldn't the money he gave to the credit card company be better utilized in building a new factory, which produced cheaper goods? Or perhaps building a new road which cut his daily commute to work?

What about the money which went overseas to the outsourced factory? When overseas products are bought it transfers wealth overseas. Over the last 20 yrs there has been a major improvements in living standards Asia with very little improvements in the western world. Asians in general are great savers, maybe there is a lesson to be learned there.

A shift to frugality would mean a deep recession. However a restructuring of the economy would probably lead to long term improvements.

As a side note - Credit crunches/Recessions are fantastic for those who are frugal and save. Fortunes can be made buying assets at distressed prices from people who are over-leveraged.

Guest's picture
Scott

I think that one of the reasons why buying an expensive television on credit makes one feel wealthy is because we live in a world full of abstractions. The majority of my banking is done through my bank's web-site. The only checks I write are for my doctor appointments and monthly rent. I rarely pay for anything in cash, preferring to use debit or credit cards (I always pay my balances in full). My pay-checks are direct-deposited to my bank. It's not much of a stretch to say that our money is literally floating our in the ether. I have six-figures in cash savings, but have never held in my hands more than $1,000. It takes discipline to understand, respect, and value something which is so intangible.

I think that when people splurge on expensive toys, it reflects a desire to have a tangible representation of wealth. I don't think this is anything new. But it's easier to spend frivolously when debt and savings are just numbers on paper or, more increasingly, pixels on a computer monitor.

Guest's picture
msnln

I think by general population being more frugal will likely limit the swings we have seen in the economy. The reason for this would be that consumer habits will not be dictated by the general economic conditions. When people see imaginary net worth go up, they get the wealth effect created by the mirage and go on spending binge. This creates me-too effect on people who are not as well off and they follow suit with borrowed money. When the upswing ends, the piper has to be paid but there is no money left! What is left are junk people bought that is clogging their homes, that inevitable end up in dumps or selling for pennies on the dollar. This causes contraction in spending and many miseries, which leads to recession.

If people were more responsible with their personal finance and were frugal, their spending binge would not have occurred and consumption would remain constant regardless of the economy. Obviously, this will cause the boom cycle to be less extreme as we have been with dotcom and housing.

During the recessionary periods, people would continue to spend frugally, similar to during expansionary periods as they would have saved up money in savings for rainy days. As such, recessionary affects would be short-lived, or at least, not as bad as we have experienced as consumer spending would continue, which will stimulate the economy into recovery.

By looking at growing economies, this we can see examples of this, especially in Asia. During the 70s and 80s, Japanese economy grew double digits. This was followed by Asian Tigers economy in the 90s and China over the past 10 years. When these economies discover buying on credit was when the growth ended and started experiencing similar swings as we have seen in the US. During the growth phase all you hear is how the people in these regions are saving 30-40% of their income but by the time their economies falter, you hear about excessive consumption that brought them down. I think we should relearn our lesson from our past mistakes.

Guest's picture
Robert

If everyone were frugal and reduced ou needs then I'm sure all the factories and financiers would turn their attention to developing new products and industries. Ones where innovation is the key and where whole new technologies are developed. (he says!)

Industry responds to what the public want, if the public want to live frugally then industry will respond in kind.

Guest's picture
Guest

There are essentially 2 things you can buy with your money (the Rich Dad Poor Dad guy explains this). One is goods, the other is investments. Investments allow you and your children to profit from other people's work, by owning (or having shares in) businesses, loans etc. The rich person owns the machine, a poor person does all the work, the rich person keeps 95% of the profit. Society would be better if poor people bought less goods and worked towards having investments, that will give them more power and stability in the future. On the other hand, it would be best if the rich would waste all their money on goods. This would give them less power and prevent their children from living off other people's work.

Guest's picture
SLV

The idea of not spending on what we spend now, and the resulting changes to our economy, is interesting to compare with peacetime vs. wartime economy. How would the economy shift if we really invested in peace-making technology, products and services (worldwide) such as those related to education, instead of war-making technology, products and services? There would be a shift, probably a painful adjustment period, but in the long term a better world - just like in a frugal economy. I think they go hand in hand.

Guest's picture
Guest

If people did stop consuming at the rate the do at the moment, then maybe the general focus would change from constant success to enjoying life and finding a divine purpose other than being a full-time customer :) ... OK maybe a bit too far?

Guest's picture
MJ Fitzgerald

Being a worker in the retail business. And formally in real estate, I can tell you that there are enough people out there that will never stop their very bad spending habits. So I don't think those of who chose to become more frugal, are going to cause the recession to get worse. I was in the Title end of Real Estate long enough to know that there are a huge number of people who will continue no matter what to keep burying themselves in debt to have, have, have.