The Marginal Propensity to Consume (MPC) sounds horrifically complicated, but like many economic terms it is actually quite an easy concept to grasp, in fact many people grasp it intuitively without actually knowing that there is even a specific economic term for it.
I've often heard people talking about how it would have been loads better if the government had've done a "people's bailout" rather than a "bankers bailout", because had people been given tax rebates, food stamps, debt write-off grants, single lump payments (sometimes described as "helicopter drops" - which is a phrase coined by the neoliberal guru Milton Friedman of all people) they would have spent it within their local or national economy, created extra demand and stimulated more economic activity. This kind of view shows an intuitive understanding of the MPC.
Consumption vs Saving
The Marginal Propensity to Consume is formally defined as the amount of a person's additional income that gets spent, rather than saved.
To give a simple example: If the government gave every worker in the country a £500 credit with their next paycheck and you spend all of yours on food, clothes for the kids, and repairs on your car, you would have a marginal propensity to consume of 1.00 (or 100%). If another person only spent £100 on an evening out and put the other £400 into their savings plan or pension scheme, they would have a MPC of just 0.2 (or 20%).
This consumption vs savings definition is the traditional one, however it neglects a couple of important elements of spending which are debt reduction and capital flight. Using additional income to reduce your debt burden (pay off a credit card or outstanding loans from a Payday lender, pay mortgage arrears, reduce overdrafts...) can be seen as a form of saving, only that the returns on these "debt repayment savings" come in the form of reduced future interest payments, fines and fees. The relationship between MPC and capital flight is a more complex issue which I'll pick up later.
Wealth
The MPC is higher in the case of poor and ordinary people than it is for the extremely wealthy. The greater a person’s wealth, the more of their basic human needs will have already been met, and the greater their tendency to save a proportion of their income in order to provide for future will be.
The marginal propensity to save of the richer classes is greater than that of the poorer classes. Thus it follows that if the government want to increase economic demand, then purchasing power must be transferred from the richer classes (with their lower propensity to consume) to the poorer classes (with their higher propensity to consume).
Disposable income
In essence, the Marginal Propensity to Consume is concerned with how individuals use their disposable income, which is the amount of money the individual has left over after paying their costs of living (usually defined as rent, tax, childcare and utility bills). The most common use of disposable income is consumption. When an individual spends a proportion of their disposable income on consumption (buying a new smartphone, going out for a meal, buying a book or getting some fancy new clothes) the retail sector of the economy benefits.
Aside from basic consumption, disposable income is also an important economic driver in another way. Without disposable income it is significantly more difficult for an individual to set up a small business or to improve their circumstances through education or training. If disposable income is lowered for millions of people (through ideological austerity) economic potential is retarded because significantly fewer people have the financial means to establish new businesses or to improve their productive capacities through education or training.
In a capitalist economy, disposable income is of paramount importance because it is one of the most important drivers of economic demand. When people have money in their pockets, they spend it, creating demand in the economy, or they save it, creating the capital reserves that the financial system is supposed to be based upon (hence the name "capitalism"). When people don't have money in their pockets, they cut back their spending, which reduces economic demand.
If people don't cut back on spending, their only other option is to get into debt in order to try to maintain their standards of living. The ever increasing level of private (corporate and personal) debt was the principal cause of the 2007-08 financial sector meltdown (over-leveraged banks, reckless lending, unsustainable property price inflation and sub-prime mortgages).
Fiscal Multiplication
[main article]
If a spending project stimulates £1.50 worth of economic activity for every £1 in investment, the fiscal multiplication value is a strong 1.5. If the project breaks even, the fiscal multiplication value is 1.0 and if only 50p of economic activity is generated for every £1 of investment, the fiscal multiplication value is a poor 0.5.
There is solid economic evidence from America that spending on poverty relief programmes such as food stamps generates far more economic activity that giving tax-breaks to the super-wealthy. When the Bush tax cuts for the super wealthy 1% were made permanent, the economic returns on each $1 of lost government revenue was a pathetic $0.29. Meanwhile an increased provision of food stamps resulted in an impressive $1.73 return on every $1 in additional spending.
It is absolutely clear from these results that providing a small amount of additional spending power to the less well off creates vastly superior economic returns on investment than giving large tax cuts to the extremely wealthy minority.
Another extremely strong fiscal multiplier is the provision of social housing, which gradually pays back the investment cost through rent, and also creates a large increase in the MPC of social tenants, because their rent is much lower than the private sector, meaning that they have significantly more disposable income than had they been paying higher private sector rent.
MPC and capital flight
[main article]
The Marginal Propensity to Consume is often contrasted with the Marginal Propensity to Save, as if spending and saving are the only two options to the individual. Things are obviously not that simple. The main problem being that national economies do not exist in a vacuum.
Other than spending or saving within the national economy, there is a third option that becomes more available the more wealthy the individual gets, and that is removing wealth from the national economy entirely. This can be done through the spending on foreign goods such as Italian sports cars or luxury yachts from South Korea for example, however this is more of a balance of trade issue than a capital flight issue. If the United Kingdom was more of a productive economy without enormous trade deficits, then more of that departing wealth would flow back into the national economy through the export of British manufactured goods.
The most problematic form of capital flight is tax-dodging, and the wealthier an individual or organisation becomes, the easier it is for them to shift their wealth out of the national economy into tax-havens.
The reason that it is so much more likely that the wealthy will extract wealth from the economy in this way is obvious. If an individual has a monthly disposable income of just a few hundred pounds, it would be an obvious false economy to pay a tax lawyer over £100 pounds an hour to build a convoluted tax avoidance scheme in order to extract this wealth, however convoluted tax avoidance schemes will create large returns for extremely wealthy individuals (such as the comedian Jimmy Carr or the Tory party donor George Robinson).The same goes for businesses. A small operation like a barber shop or self-employed builder won't be capable of producing the necessary profit in order to justify the establishment of a chain of offshore shell companies for the purposes of avoiding tax, however due to economies of scale, "offshoring" is common practice amongst major corporations (in fact 98 out of the FTSE100 companies have tax haven based subsidiaries).
Once offshore wealth extraction schemes are factored into the equation, it becomes obvious that there is more to the Marginal Propensity to Consume than the traditional way of formulating it in simple spending versus saving terms.
For more information about how tax-dodging is detrimental to the economy, see my article on the subject.
Current policy
There are two strands of policy to consider in terms of the MPC: Fiscal policy and monetary policy. The government is largely responsible for the fiscal policy agenda, and the Bank of England is responsible for monetary policy. In this section I'm going to demonstrate how both institutions are engaged in policies that result in the transference of wealth to the rich, resulting in a reduction in consumption at the national level.
Since 2010 the Tory led government have engaged in a duel strategy of ideological austerity and wage repression (destroyers of economic demand because they affect poorer people with high MPC the most) whilst simultaneously enacting policies such as cuts in the top rate of income tax and huge reductions in corporation tax, which benefit the wealthy minority who have a a lower MPC.
Under Tory rule the average wage has fallen 9% in real terms (because average monthly wage rises have risen slower than the rate of inflation every single month for three years) whilst the corporate executive class have enjoyed a staggering 152% increase in their annual remuneration between 2010 and 2012. Not only that, but the government cut the income tax burden of the highest earners by 5% in April 2013, meaning an average £100,000 annual tax reduction for Britain's 13,000 income millionaires.
In the very same month that they handed this huge tax break to the wealthy (low MPC) class, the Conservative led government hammered poor and ordinary people with schemes like the Benefits Up-rating Bill, the public sector wage freeze and Bedroom Tax.
It is absolutely clear from these actions that the government has contempt for the Marginal Propensity to Consume, they are simply engaged in enabling a massive transference of wealth from the poor and ordinary to the wealthy, no matter what the cost to the economy.
The Bank of England are no better with monetary policy. Their policy of Quantitative Easing (magicking up money to pump into the financial sector, whilst holding interest rates at an all time record low for 4 consecutive years) has resulted in a massive transference of wealth to the super-rich minority. Their own figures show that 40% of the benefit of Quantitative Easing went to the wealthiest 5% of households. Instead of pumping this new cash in at the bottom of the economy and letting it work its way upwards, stimulating economic activity on its way, the Bank of England pumped it directly in at the top of the economy.
With the government and the Bank of England pursuing policies that result in transference of wealth to those with the lowest marginal Propensity to Consume, it is hardly surprising that the UK economy is suffering the slowest economic recovery in a Century, that the UK is recovering more slowly than any other major western economy bar Italy, and that the economy has still not recovered to pre-crisis levels almost six years after the financial sector collapse began. Given that both the government and the Bank of England have enacted policies which reduce the national MPC, it is almost as if there is an agenda to deliberately prolong the economic crisis.
Conclusion
Given that the Chancellor of the Exchequer George Osborne has absolutely no economics qualifications, it is possible to imagine that the guy is completely ignorant of the Marginal Propensity to Consume, however it is impossible to imagine that absolutely nobody in government, and nobody at the Bank of England has heard of it either. That both institutions have been enacting policies that reduce the national consumption by transferring wealth from the high MPC majority to the low MPC minority, suggests the possibility that the prolongation of the economic crisis is actually a deliberate macroeconomic strategy.
It is easy to understand why a Tory led government would ignore the MPC and damage the economy by reducing the income of the majority, in order to fill the pockets (or should I say offshore bank accounts) of the wealthy minority: Serving the interests of the wealthy establishment, at the expense of the majority has always been their game.
It is more difficult to see what the Bank of England have to gain by transferring wealth to the already wealthy, and robbing the pension schemes and savings accounts of the ordinary to do it. Perhaps it is simply that they so many of them have been indoctrinated with neoliberal pseudo-economic mumbo-jumbo when they studied PPE at Oxford, Cambridge or LSE (as most of them did).
Whatever the case, the fact that the UK is enduring the slowest post-crisis economic recovery in recorded history, and that the political and financial establishment are simultaneously working to ensure an unprecedented transference of wealth from the high MPC majority to the low MPC minority hardly seems like a coincidence.
Another Angry Voice is a "Pay As You Feel" website. You can have access to all of my work for free, or you can choose to make a small donation to help me keep writing. The choice is entirely yours.
The other consequence of imposing economic strategies that reduce disposable income is an increase in the amount of personal debt in the system as millions of families are forced to borrow more (in order to keep the rooves over their heads, clothes on their kids and food in their bellies). When people do rely on borrowing, this further eats into the amount they can spend in the "real economy" by increasing the proportion of their disposable income that goes towards making interest repayments. A Consumer Credit Council Service study recently found that over 24% of UK household disposable income is spent on nothing more than interest repayment. The rising levels of personal debt in the UK and the rapid spread of parasitic ultra-high interest payday lenders has already been documented. It seems that the Tories have refused to learn the lessons of the financial crisis; that predatory lending, high levels of debt and unsustainable borrowing are a recipe for a catastrophic economic meltdown.
Large scale systematic reductions in disposable income have the consequential effects of reducing demand and increasing debt within the system. At a time when the government should be taking decisive measures to stimulate economic growth and reduce the amount of debt in the economy, they are pursuing an ideologically driven austerity agenda which is doing the exactly the opposite.
After two years of economic stagnation and the recent return to the status of "technical recession" it is clear that the Tory "austerity drive" has harmed the UK economy in the way that I have described. The Tories have overseen a large reduction in household disposable income, leading to a fall in demand and a rise in personal debt. Other ideologically driven policies from the Tories look set to intensify the Disposable Income/Demand/Debt economic decline, especially their reforms of student finance which look set to lumber millions of low-mid income students with an "aspiration tax" to be subtracted from their disposable income, preventing them from investing it in economically beneficial activities such as starting their own businesses, collecting savings, making investments, contributing to pension funds or simply spending it.
The Tories have demonstrably created a massive reduction in the amount of disposable income in the economy via massive public sector layoffs and pay freezes, pension attacks and welfare cuts, all exacerbated by huge above inflation rises in utility and transport costs and the Bank of England's stagflationary fiscal policies.
the incompetent over-promoted rich boy.
Even though the case for Tory incompetence is a reasonably strong one, the fact that similar ideologically driven "austerity" schemes are being pursued across the rest of Europe and much of the rest of the western World suggests that this seemingly insane adherence to destructive self-defeating austerity is not just an affliction suffered by the English upper classes. This leaves us with the important question; if these policies are not driven by sheer economic incompetence, what would would make the Tories want to pursue such an socially and economically destructive strategy?
1 Neoliberal orthodoxy: After three decades of "neoliberal orthodoxy" the political classes are incapable of thinking outside the orthodox paradigm of more privatisation, less regulation, less labour rights, more tax cuts for the rich, etc. The fact that their beloved neoliberal economic theories were completely invalidated by the neoliberal economic meltdown which demonstrated firstly that deregulated financial sector markets do not self-regulate ("the invisible" hand is a myth) and secondly that state intervention is necessary (rather than "evil") because without it the neoliberalised financial sector would have collapsed entirely, taking the relatively tiny "real economy" down with it. The problem with this idea that if the political classes are sticking with the defunct paradigm of neoliberalism because they are incapable of "thinking outside the box", this is pretty much the same as the argument we are trying to counter; that they are clueless and incompetent.
and the US in danger of joining them should the Republicans win,
demand for imports from the UK is going to be diminished.
This explanation is backed up by Tory justification of their much criticised regional pay plans, that by reducing public sector pay in poorer areas, the private sector will face less wage competition in these areas, allowing them to offer poorer wages and working conditions and therefore create more jobs.
The problem with this competitivity drive explanation is the fact that the Coalition have provided £40bn to the IMF in order to impose similar austerity measures through Structural Adjustment conditions on their loans in other European economies such as Spain, Greece and Ireland. The effect of these austerity measures is to reduce demand in Europe meaning that there will be no improvements in the balance of trade. If all of the western economies impose the same kind of cost cutting measures simultaneously, these socially and economically damaging cuts wont actually improve competitvity or the balance of trade at all, since demand is going to be reduced across the board.
3. The China block: One theory that is doing the rounds is that these austerity policies are actually a coordinated western government strategy to curb Chinese economic expansion and their growing domination of global trade. The theory is that these austerity policies are a deliberate strategy to reduce household disposable income in order to deter consumer spending on Chinese manufactured goods. The problem with this explanation is that Chinese factories produce an awful lot of cheap crap, and in times of economic turmoil and reduced disposable income, consumers are much more likely to buy cheaper alternatives than quality branded goods. One area of the UK economy that has been booming since the global economic meltdown is the "Pound Shop sector" which is based on the model of selling cheap low quality Chinese goods at bargain basement prices.
To give a hypothetical example; if Mum has been made redundant and Dad has suffered four consecutive years of pay freezes, they are much more likely to buy cheap Chinese manufactured birthday presents for their kids than high quality British or European manufactured branded toys like a Hornby railway set or a pack of Lego (even if they do choose branded European goods, manufacturers such as Hornby are still actively shifting their production to China too!). Since Chinese factories produce the kind of cheap, poor quality goods that people tend to buy when they can't afford to let quality or ethical reasons determine their choices, reducing household disposable income is likely to harm the Chinese manufacturers much less than it actually harms local manufacturers.
4. Debt creation: The introduction of the highest public university fees in the World for English students has demonstrated that the Coalition government have absolutely no qualms about driving people into enormous amounts of debt. Perhaps their attacks on disposable income are actually intended to drive more people into debt? If people find that their household disposable income is being eroded away, they can either make cutbacks or they can take on more debt in order to make ends meet. The beneficiaries of increased borrowing would be the financial sector who could generate huge profits by lending on the Central Bank super-low interest "giveaway loans", and their Quantitative Easing windfalls at eye watering interest markups.
The fact that the majority of Tory party donations come from the financial sector and that one of their biggest donors (Adrian Beecroft) is the director of a private equity fund that owns the predatory lender Wonga.com gives some credence to this theory, however the main reason that the economy is in such a mess in the first place is that the financial sector inflated a vast speculative bubble built on "easy credit" and unsustainable debt. The narrative of the economic crisis has been all about recapitalisation of the banks and the difficulty in obtaining credit. Incentivising people to borrow more money in order to maintain lifestyles that they cannot afford or just so they can make ends meet (in the cases of poverty stricken families) is exactly the opposite of sustainable recapitalisation. It is not beyond the realms of possibility that the Tories are trying to recapitalise the financial sector by driving millions of people to take out high interest loans whilst the Bank of England and European Central Bank provide the financial institutions with an almost limitless supply of cheap money to lend out at huge markups, however this cannot be seen as a sustainable economic policy.
5. Reduce social mobility: The biggest barriers to social mobility are low disposable income (lack of ability to accumulate capital), debt and lack of education. All three of these seem to be deliberate Coalition policies. The reasons a Tory led government would want to favour establishment interests ahead of the interests of ordinary working people or the wider interest of creating long term economic stability are as manifest as they are obvious. The financial sector provide the majority of Tory party funding, most of the rest of their funding comes from other capitalists and their traditional base, the landed gentry. The Tory party is riddled with people that went through the establishment training system of public school education and they boast a cabinet of multi-millionaires.
The Tories have repeatedly demonstrated their absolute contempt for the interests of the the ordinary working people that they have been known to refer to as "the enemy within". The desire to protect the old establishment of landed gentry and the public school old boy network is one of the deepest Tory desires, protecting their own personal financial interests and those of their corporate and financial sector backers are also core Tory motivations. The best way to prevent the downwards mobility of over-promoted public school old boys, reckless financial sector gamblers and greedy corporate fat cats is to prevent the upwards mobility of talented and hard working ordinary people.
Several of the coalitions policies can already be seen as blatant attacks on social mobility. The student fees hike which will lumber hundreds of thousands of kids from low-middle income families with vast unpayable debts and end up disincentivising thousands more that are rightly put off by the prospect of racking up £50,000 or more in debt that will grow at well above the rate of inflation unless they manage to poach themselves a £50,000 a year job from under the noses of the public school old boy network. Regional pay plans will lower pay in poor areas and look set to damage vital public sector services in these areas by incentivising staff to move to more affluent areas in search of better pay. George Osborne's tax changes look as if they are designed to transfer even more of the burden of taxation from capitalists (corporation tax cuts) and the super rich (cutting the 50p rate for earnings above £150,000) to consumers (hiking the VAT rate).
The suspicion that the Tories are deliberately slashing the incomes of ordinary working people and driving millions into debt as a deliberate policy to protect the interests of the establishment elite by reducing the social mobility of the "lower orders" is backed up by the fact that in 2011 the richest got richer, whilst the majority suffered the austerity.
It is fairly obvious that the increased competitively and the "China block" explanations are worthless. If reducing aggregate demand was about increasing exports and closing the trade gap then funding the IMF to impose similar policies across the UK's main export markets would be utterly self-defeating. If austerity is a western conspiracy to confront Chinese manufacturing might, it isn't going to work because squeezed consumers are more, not less likely to buy cheap, low quality Chinese goods. Protectionism in the form of trade tariffs would make a much more effective western plot to slow down China's economic growth than a set of policies that result in creating recessions across their own economies.
The government are still keen neoliberals, even though many of the central neoliberal principles have been repeatedly and comprehensively invalidated, the Tories are so enraptured by the ideology that they are even determined to privatise the police forces that were more than happy to work as Margaret Thatcher's private militia in the early days of the neoliberal revolution. That the Tories are so obsessed with imposing defunct ideologically driven neoliberal pseudo-economics is pretty much the same as being incompetent and economically illiterate, but the question still remains. Why are they so determined to stick with invalidated neoliberal dogma? I think the answer lies in proposals four and five. The Tories are determined to protect the interests of their own class, they are after all the party of the establishment. The best way to protect the interests of the establishment is to reduce the upwards social mobility of the "lower orders" by restricting their access to capital (disposable income) by driving them into debt and by disincentivising them from getting higher education or making them pay up to 9% of what should be their disposable income in an "aspiration tax" that the children of the establishment elite can easily avoid. Driving ever more people into debt would have the added bonus of helping out the financial sector gamblers that are the main source of Tory party funds.
The Tories are the party of the establishment, their party is riddled with millionaires and public school establishment trainees and they take the vast majority of their party funding from establishment sources. The following flow diagram gives an illustration of how several government policies reduce social mobility, decrease disposable income, increase public debt and protect establishment interests.The fact that these reductions in disposable income and the increases in debt serve to reduce economic demand and damage the wider economy doesn't seem to matter to the Tories, since their core objective is only to protect establishment interests rather than to run a stable economy for the benefit of everybody.