Avocado Toast and the Paradox of Thrift
I find myself in the position of doing a Hot Take on an already derided internet article, the recent uproar over the comments by Tim Gurner, an Australian real estate investor, that millenials should stop paying for “avocado toast” and instead save their money. Apart from being critifized for being out of touch, the comments bring up two important economic issues. One, long known about, is the “Paradox of Thrift”. Another, more recent problem, is the overspecialization of resources.
The Paradox of Thrift: A Thought Experiment on Consumer Spending
What if the young (and old) people of Australia stopped going to restaurants, cafes, bars, or other venues of entertainment? What if they cut 10, 20 or 50 percent of their discretionary spending on non-necessities? If a single person does that, they are showing personal restraint and thriftiness, traditionally virtuous behaviors. But this isn’t a single person: this is everyone in Australia. The first, obvious result is that all of those businesses, employing 18% of Australia’s labor force, (this is a combination of 11% of people working in retail and 7% working in hospitality), start having lower revenues and profits, and start cutting back on labor costs and upstream supplies, which starts affecting the 3% of Australians employed in wholesale trade, the 7% of Australians involved in manufacturing, and eventually, the 9% of Australians employed in professional services. And of course, the 2% of Australians working in real estate services. In other words, this campaign of personal thrift makes the Australian economy contract. At least, that is the theory: there has never been, to my knowledge, a spontaneous contraction of the economy brought on by personal thrift, but this is what happens when people stop spending their money when there is an external or systemic shock to the economy. In either case, this contraction would lead to deflation, where restaurants cut prices to attract consumers, but also cut wages and payments to upstream suppliers. Deflation, much like inflation, can feed on itself, and is generally considered to be a bad thing.
The next step should be that the banks, flush with the money saved through skipping those expensive lunches, are more willing to lend money. Interest rates and terms drop as banks try to attract investors. In a rational economy, people would borrow money cheap and launch a business. But the deflation and unemployment discourage people from starting new ventures, because there are few customers available. The economy settles into a depression. This is the classical view of the Paradox of Thrift, one of the cornerstones of Keynesian economics. Notice that it has never happened exactly as mentioned in this example, because most times that people start saving money, it isn’t out of a choice, but because they are experiencing, or expecting to experience, unemployment or lower wages.
Indeed, to return it to Mr. Gurner’s comments, one of his first investments was sending $150,000 on a gym. If people had been more thrifty and had decided to save their gym membership fees and instead go for a run in the park, he might be complaining from the other side right now. His fortune depends, in some measure, on the same buying of luxury goods and services that he decries.
Why Savings is Not Just Money Under a Mattress
The second issue, an issue that is becoming more important for Millenials, is labor (over)specialization, and how this relates to the very nature of savings.
Savings is not just “not spending money”. If you put a wad of bills under a mattress, you are not, in economic terms, saving it. Savings, in economic terms, happens when someone foregoes consumption to increase future production. I have 5 dollars in my bank account. If I take it out of the bank, I can buy some avocado toast. If I leave it in the bank account, the bank can use that money to invest in some type of capital asset, something that can produce more in the future. Economics is not the study of money, but of choices. By choosing to not spend our money, and to leave it in a bank, we are choosing to increase future production.
In our example, real estate prices are high, which means there is already a strong demand for them. When people stop buying avocado toast, the bank can loan out more money. Real estate developers, now with more and easier money, hire more people to build more buildings. Ignoring the psychological effects of the temporary unemployment and deflation, all of the recently unemployed service industry people are hired to build houses and apartments across Sydney, and the increased supply of housing brings down the price for young people, who can now own a home. In other words, savings is an efficient way to shift resources from immediate consumption to production of different assets.
There are two problems with this: first, the psychological effects of deflation and unemployment, that make investors less likely to borrow and spend money. Secondly, do you want your bartender to be wiring your house?
The problem with the idea that savings and investment shifts resources from consumer goods to building long term assets is that the resources needed to produce, say, avocado toast, are not readily transformable into the resources needed to build a house. Classical economics was developed between the 1770s and 1830s, when Britain and Western Europe were switching from an agrarian to an industrial economy. At the time, the labor that went into developing different products was rather fluid: if customers wanted to buy more bread and less candles, the people and equipment in the candle factory could fairly readily be transferred to the production of bread. One of the problems with the current economy is the long lag time in retraining workers. In other words, when you save money by not buying avocado toast, the sandwich artisan doesn’t end up willing and able to work in the construction trade four weeks later. What you instead have is unemployment with some workers, while more money would be chasing the same limited pool of skilled workers. It would be deflation in some contexts, and inflation in others.
Mr. Gurner’s advice then, would (following these theories) lead to either widespread deflation and unemployment, or to depression in some sectors while leading to inflation and shortage in others.
The Right Question, the Wrong Answer
Mr. Gurner’s comments actually do address a very important and seemingly confusing economic problem: why is an economy that is so good at producing some things, such as food, consumer goods, and hospitality & entertainment, still have a problem producing other things, such as housing, education and health care (the three largest anxiety producers for most people under 40). In much economic thought, the resources in places where there is a surplus should transfer to areas where there is a deficit. Avocado farmers should retrain to be nurses, until the supplies are evened out.
That is not how our economy has worked. It is a large question, and while it is right that Mr. Gurner brought it up, his moralizing and short sighted answer offers no real solution.