Consumers, consumption : US versus Europe
Because of the big contribution of C to growth, fluctuations in consumption are a key element
of booms and recessions. Problems of data finding: I have found much more about US than
about Europe as a whole (data per country is more common than aggregate data at the
European / Euro Area level).
1. Consumption in relation to income and saving
Consumption has to be analyzed in relation to saving. They are the two sides of the same
coin, the coin being income. Consumption and saving depend on expectation of the future.
The way people anticipate their future determines the amount of income they spend or save.
What households spend out of their income is called the average propensity to consume.
Keynes (1936) was the first economist to introduce the consumption function: he found that
people increase their consumption when their income rises, but not by as much. When income
rises, consumption rises too, but slower. In other words, the average propensity to consume
falls as income rises. The marginal propensity to consume is between zero and one. Short
time-series confirm Keynes’ theory but long ones reveal that average propensity to consume
does not fall as income rises.
Keynes’ theory was incomplete because it considered only the present. Yet, when people
decide how much to spend or to save, they look both at the present and at the future.
Keynes stated that a person’s current consumption depends mostly on his current income.
Irving Fisher later showed that consumption is based on the resources the consumer
expects over his lifetime. A person who suddenly loses his job can sustain his consumption
by borrowing money or taking from his savings, until he finds another job. This behavior is
called consumption smoothing. Consumers make intertemporal choices.
Franco Modigliani’s life cycle theory of consumption says basically the same thing but insists
on other factors than income, in particular the total wealth (which includes the value of
housing).
Milton Friedman’s permanent income theory of consumption (1950’s) goes in the same
direction as well. It says that consumption is proportional to permanent income.
Permanent income is the average income, transitory income is the random deviation from that
average.
Keynes suggested that C = f(current income)
Later works completed C = f(current income, wealth, expected future, interest rates)
2. Europe vs. US: a comparison hard to make and not necessarily relevant
Europe: low average consumption but a variety of consumption patterns
What do we talk about when we say Europe? The Euro Area, Western Europe or Europe as a
whole, West and East included? Even if we limited our analysis to the Euro Area, it would
make little sense given the variety of configurations. Indeed, in Europe, the ratio of
consumption to income varies a lot from one country to another.
The growths of consumption and income in five European countries
Consumption has been rather weak in the Euro Area over the past five years.
France: Consumption growth = income growth
Germany: Consumption growth < income growth (more saving because of labor market
reforms)
Netherlands, Italy, Spain : Consumption growth > income growth
Even in the last three countries, we can see that the levels of consumption and income are
very different from each other. So Europe is not homogeneous.
Apart from that graphic, I have found no other information about consumption in Europe as a
whole.
US: strong consumption, little saving
American commercial balance has been structurally unbalanced for many years because of a
strong domestic demand. Consumption makes for 70 % of GDP in US.
In 2003, US national saving amounted only to 13,5 % of GDP = lowest rate in US history
since the Great Depression and one of the weakest in OECD countries.
This situation is seen as worrisome by many who find that US is suffering from overconsumption. Yet, it does not prevent the US to have a strong growth and to have recovered
quickly after the past few slowdowns. It must be noted that other countries such as Canada,
Australia and the UK have low levels of domestic saving and experience a strong output
growth as well.
One can wonder if this situation is sustainable. JP Cotis, who is not alarmist about US current
high consumption, says it could be a source of concern for the future. But let us now examine
the causes of that American specificity.
In the second half of the 1990’s, US household net worth increased while domestic saving
decreased.
What was observed is called a wealth effect: an increase in wealth causes households to
increase their consumption and decrease their saving.
Milt Marquis affirms that, to a large extent, the low personal saving rate in the US economy is
a systematic response of households to the increase in financial wealth. The decline in the
saving rate at the aggregate level was primarily the result of a response by wealthy
households to a surge in stock market wealth. These families, who owned valuable
portfolios, experienced the largest capital gains. As a consequence, they tended to save less
and to consume more.
Even if we put aside the heterogeneity of Europe to establish a comparison between the old
continent and the US, reasons to account for this difference are hard to find. There is little
consensus among the economists about why the US consume so much and save so little and
why Europeans consume so little and save so much.
AL-EYD, A., BARRELL, R. (2006), ‘Consumption in the Euro area’, National Institute Economic Review, No.
195.
COTIS, J.-P., COPPEL, J., DE MELLO, L. (2004), ‘Is the US prone to “over-consumption”?’, OECD
Economics Department Working Papers.
MANKIW, G., Macroeconomics, 4th edition, World Publ., New York, 2000.
Web site of the Federal Reserve Bank of San Francisco: ‘What steps can be taken to increase savings in the
United States economy? (02/2002)’