Intro: While we often hear that consumption drives growth, in reality it is the productivity of businesses that creates growth by investing in the production of goods to satisfy consumer demands. Their success depends on the availability of real savings (land, labour, and capital) in the economy and the business environment.
All economic growth is the result of the growth of the working population and how productive they are (labour productivity). The productivity of labour depends on the availability of savings in the economy and how productive businesses are at using these savings to invest in producing things consumer want. This productivity of investment ultimately depends on the country’s business environment.
Note that by savings, this does not mean money. Money is merely the medium of exchange representing the real amount of available resources in the economy; from fields of crops to car manufacturing plants to the vast array of intellectual capital. Everything that currently exists in the world that can be used in the production process is the definition of savings. In other words, real savings are made up of everything produced and not consumed.
The C+I+G+NX Framework
Real GDP data is typically reported in the form of C+I+G+NX. However, these spending components do not exist in isolation, they are a representation of the type of goods and services that businesses produce. When economists say that growth is driven by consumption, what they really mean is the production of consumer goods and services, as these things have to be produced before they are consumed. Keeping this in mind is particularly important when it comes to looking at the impact of fiscal and monetary policy on short-term growth.
All Growth is Driven by Businesses, Not Consumers or Governments
While it may seem like a rise in government consumption on military equipment, for example, benefits growth by increasing G, or a rise in consumer spending due to tax cuts benefits growth through increasing C, the good s that governments and individuals consumer need to be produced in the first place by businesses. Let’s say that increased hiring in consumer-focussed industries leads to increased production of consumer goods. In terms of GDP by expenditure accounting, the extra output created by these extra workers shows up as increased consumption expenditure as these goods are consumed, but that doesn’t mean that consumption drove the economy. Growth resulted from increased profit opportunities in consumer-focussed industries that led businesses to increase investment in labour.