Saturday, December 10, 2011

Advertising is (Mostly) a Waste of Resources

Advertising is (Mostly) a Waste of Resources

In 2008, the year for which I have figures (Outsell July 14, 2008 Third Annual Outsell, Inc. Study Forecasts $412.4 Billion in 2008 Advertising and Marketing Spending, of which $250 Billion or so was directly for advertising) That works out to some $830 for every man, woman and child.

Advertising and Marketing work out to about 3% GDP. But what is produced?

Advertising and conservation of money: People can only spend so much. They can only spend as much as they earn. Less taxes, of course. Oh, sure, they can go into debt, and spend more now. But that means, in the not so long run, they end up spending less than they earn, since they cannot spend what they lose in interest and charges on the loans they take out. Or they can save and spend a little less than they earn now, and in the not so long run, have a little more to spend than they would otherwise, assuming they gain a little extra in interest. But that’s it. That’s the most people can spend, and it doesn’t matter how much is spent on advertising. So advertising is at best a zero sum game. Advertising cannot make people spend more. In fact, if it encourages people to go into debt, it causes people to have less to spend, in the not so long run.

So spending on advertising is at best competing for a fixed quantity of dollars. But in the real sense the more resources are spent on advertising, the fewer resources are available for production of useful goods, and services, and the poorer society is. The poorer the consumer is. And the poorer the producer is.

Advertising is an example of what’s called a failure of composition: One business, if it advertises, gains a benefit in increased sales. But if all businesses advertise, then they all lose, because the market can only be so large. In fact, the market is actually smaller due to the fact that the more advertising, the more society’s resources are diverted from productive activities to paying for that advertising. The less money is available to produce other, perhaps more desirable, goods and services for society, so the poorer society is. Unless you consider money spent on advertising as a net contribution to society, like, say, art. But what kind of art does it qualify as?

Now what is true in general is true specifically for the holidays: The holiday shopping season does not increase consumer spending. Advertisers spend more, and yes, consumers do spend more during the holidays. But, they simply have only so much to spend each year, so the existence of a holiday season makes no difference in the total that would be spent each year, and thus the total that is spent.

Consider Black Friday. Where one store opens early, it has an advantage. Where all stores open early, there is no advantage, but all stores incur additional expense.

This brings us to a clear case where regulation makes an economy more efficient, and that case involves what used to be the so called Blue Laws. These were laws which banned most retail stores from being open one day a week, usually Sunday. (Pharmacies were a notable exception, but even they could only sell medical related merchandise.) Now as we argue, annual personal expenditures are conserved. That is, having seven days a week or six days a week of shopping makes no difference to the amount of money available to be spent. No more is spent in seven days than would be spent in six. Or looking at it the other way, no less would be spent in six than is spent in seven. But with stores open seven days, what we have is the increased expense of keeping those stores open the extra day. Since retail trade represents about 7% GDP, a reduction of 1/7th of its (real) expenses would result in a 1% increase in the efficiency of the economy. About $130 billion, or about $430 would be made available for every man, woman and child in the economy. ( We say ‘real’ because we’re talking actual resource usage, electricity and wages, not nominal expenses like rent. Rent isn’t going to change, but paying rent isn’t consuming resources. It is merely a transfer of demand (for resources) from the retailer to the landlord. Also, the actual ‘real’ savings is probably going to be somewhat less, since heating, and cooling, of the store must be done seven days a week, to some extent, whether the store is open or not.)

This is another example of the failure of composition. Clearly, if just one store is open on Sunday, that store will have more business. It will take business from its competition. But with all the stores open on Sunday, we have seen that there can’t be more business for all the stores, and there is instead the added expense of the stores being open seven days instead of six. Having his store open seven days instead of six is, for a retailer, a very significant expense, an expense he passes on to his customers. His customers, paying more for each item, are not able to buy as much stuff, and so are less well off. Consumers pay, in real goods and services, real resources, for the convenience of shopping on Sunday.

Now something similar to the increase in efficiency which would be obtained by closing stores one day a week is being driven by increased retail selling over the Internet, which is reducing the number of brick and mortar stores, and thus the expense involved in operating them. On the other hand, Internet competition is forcing those stores which remain open to be as convenient as possible, thus inducing them to be open on Sunday.

Some advertising is desirable, bringing the buyer to the seller, and informing the buyer of his choices. But more than that is, from a social point of view, harmful, not because it influences buyers into making sub-optimal choices, (which it may,) but because it consumes resources to no one’s benefit.

The irony, of course, is that the billions of dollars per year spent on advertising have not lead to an increase in corporate profits, but rather an increase in expenses, and a decrease in profits. Though not in percentage of profit. Advertising simply does not increase the amount of money available for the consumer to spend, but its expense must be borne by all producers and consumers. The result is higher prices, and a reduction in the quantities produced and consumed. The more advertising, the greater the expense.

A technical note: The degree to which the producer or the consumer bears the cost of advertising depends on the relative elasticity of the supply and the demand, just as with taxes: Elasticity of demand is the ratio of the change in quantity demanded to the change of price. Elasticity of supply is the ratio of the change in quantity supplied to the change of price. A large elasticity implies a large change in quantity leads to a small change in price. A small elasticity implies a small change in quantity leads to a large change in price.

Now if demand is less elastic than supply, consumers bear the greater burden of the cost of advertising. If supply is less elastic than demand, producers bear the greater burden of the cost. From this, we would expect producers to spend more money on advertising relative necessities, such as food, than discretionary goods, such as automobiles, or jewelry.

But there is significant advertising in many discretionary goods, where the producer would seem to bear most of the costs.

Now in today’s global economy, where supply is often world wide, supply tends to be very elastic, and so for most goods, the burden of advertising is borne by the consumer. In the case of jewelry, and articles geared for the wealthy, for whom price would seem to be no object, it would appear that demand is relatively inelastic. Thus a disproportionate amount of money would be spent on the advertising of luxury goods. On the other hand, there does not seem to be so much advertising for interchangeable necessities, such as different brands of gasoline.


  1. What about informational inefficiencies rectified by marketing?

    In other words, there are some more beneficial transactions that I could enter into that I do not know about, therefore I enter into some less beneficial transactions. The less beneficial transactions result in a lower surplus from the transaction to both sides.

    Now when a marketer makes me aware of a more beneficial transaction, even if aggregate spend is conserved (as you hypothesize), the total utility generated by all the transactions is higher, so even accounting for the "wasted" spend of advertising, we end up Pareto improved.

  2. Here's another idea. Luxury goods are about signaling behaviour, so their utility is strongly related to other people being aware of their expense and desirability. Thus advertising is integral to the functioning of the product category. In some sense the advertising is the product for luxury goods.

  3. Thanks, Paul. I did concede that some advertising was beneficial, although I didn't look at it from society's point of view. But, I think the amount of advertising we have now goes way beyond Pareto optimality, though, to a sub-optimal equilibrium where companies are forced to spend because other companies are spending. (Because they are forced to spend because...) Thus more spending than beneficial. Remember, all marketers are trying to make you aware of a more beneficial transaction.

    At the least I would be very surprised if this equilibrium were socially optimal. At best there seems to be too much information, at worst a lot of it is noise.

    There is another limit advertising comes up against, and that's the limit of individual attention: A person only has so much attention to give. This is one reason why (most?) advertising is based on emotional, rather than intellectual appeal. It simply takes less time and effort to respond to one's emotions rather that to reason choices through.

    Is an economy Pareto improved when it is based on meeting people's desires, or when it is based on meeting people's needs? Or does this depend on other factors, like how wealthy a society is?

    This raises other questions: How much advertising is optimal? Do societies tend to converge on this value, or, as I claim, not? And if, as I claim, there is cost, how is it expressed in society? Does advertising 'deform' a society, eg encourage global rather than local supply chains, concentrated rather than distributed production networks? Even if advertising works to the individual's net benefit, is it socially pernicious? (The documentary
    The Century of the Self addresses this.)

    That's a nice observation about luxury goods. Certainly the advertising is at least part of the value, and one the wealthy certainly pay for.

  4. Three challenges...

    "So spending on advertising is at best competing for a fixed quantity of dollars."

    I'm not so sure about that. Advertising is like government stimulus spending, where the plan is to stimulate consumers to spend. If government stimulus can work to expand the economy, then advertising can work to expand the economy. If not, then not.

    "Where one store opens early, it has an advantage. Where all stores open early, there is no advantage"

    When one store fails to open early, it has a disadvantage. This doesn't contradict what you said, but it drives the process I think.

    "Since retail trade represents about 7% GDP, a reduction of 1/7th of its (real) expenses would result in a 1% increase in the efficiency of the economy"

    What if we allow stores to open only two days a week? Will efficiency improve by 5%? Maybe it would be best, then, never to allow stores to open at all??

    ... One unfounded assertion:

    "How much advertising is optimal? Do societies tend to converge on this value, or, as I claim, not?"

    Adopting supply side economics tends to increase the amount of advertising.

  5. I think advertising, in this respect, is more akin to monetary, rather than fiscal policy. If my earnings haven’t changed, and if I borrow now, and spend more now, I have to pay back, and spend less, later. Monetary policy lowers the interest rates, encouraging me to borrow now, but I still have to pay back later. Advertising encourages me to spend more now, but it doesn’t change my earnings.

    An increase in fiscal spending is more like an increase in earnings. I earn more, so I can spend more. Of course, these days our government borrows to pay for its stimulus spending, so eventually it is expected to pay that back. So the ‘increase in earnings’ is temporary. In theory, this would be recovered with higher tax receipts, when the economy recovers.

    Right now monetary policy is against the zero interest bound, and cannot go any lower.
    Can advertising get any louder?

    Store openings are, from a social point of view, a min-max problem: maximize flow of goods while minimizing costs. The claim is closing one day does not reduce the flow of goods, while significantly reducing costs. Two days may be better! Many businesses, professions like doctors and lawyers, are only open 5 days per week. But the more days of closure you consider, the more non-linear effects you have to consider, and other costs enter in. Imagine stores open one day a week. More traffic, so they would have to be bigger, and more expensive. Less convenience. There’s a trade off.

    Remember, Blue Laws were in force for many years, and the economy ran just fine. I offer a secular explanation, and thus a justification, for a spiritual pronouncement. The issue has arisen in Connecticut wrt to liquor sales on Sunday, which are currently forbidden. Many retailers do not want to be open on Sunday, and are opposed to lifting the ban. I’m not sure how, or if, it has been decided.

    “Adopting supply side economics tends to increase the amount of advertising.”

    You might think so, assuming ‘supply side economics’ was a coherent policy. Does advertising increase during depressed times, when there is a shortage of buyers? More sales? Hmm.

    1. Liquor stores in Connecticut are now open on Sunday, and have been for a while. Like a few years, maybe? I forgot about this comment.

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