THE ASSAULT ON SAVING
FROM TIME IMMEMORIAL proverbial wisdom has taught the virtues
of saving, and warned against the consequences of prodigality
and waste. This proverbial wisdom has reflected the common
ethical as well as the merely prudential judgments of
mankind. But there have always been squanderers, and there
have apparently always been theorists to rationalize their
squandering.
The classical economists, refuting the fallacies of their own
day, showed that the saving policy that was in the best interests
of the individual was also in the best interests of the nation.
They showed that the rational saver, in making provision for
his future, was not hurting, but helping, the whole community.
But today the ancient virtue of thrift, as well as its defense
by the classical economists, is once more under attack, for
allegedly new reasons, while the opposite doctrine of spending
is in fashion.
In order to make the fundamental issue as clear as possible,
we cannot do better, I think, than to start with the classic
example used by Bastiat. Let us imagine two brothers, then,
one a spendthrift and the other a prudent man, each of whom
has inherited a sum to yield him an income of $50,000 a year.
We shall disregard the income tax, and the question whether
both brothers really ought to work for a living or give most of
their income to charity, because such questions are irrelevant to
our present purpose.
Alvin, then, the first brother, is a lavish spender. He spends
not only by temperament, but on principle. He is a disciple (to
go no further back) of Rodbertus, who declared in the middle of
the nineteenth century that capitalists "must expend their income
to the last penny in comforts and luxuries," for if they
"determine to save . . . goods accumulate, and part of the
workmen will have no work."1 Alvin is always seen at the night
clubs; he tips handsomely; he maintains a pretentious establishment,
with plenty of servants; he has a couple of chauffeurs,
and doesn't stint himself in the number of cars he owns; he
keeps a racing stable; he runs a yacht; he travels; he loads his
wife down with diamond bracelets and fur coats; he gives
expensive and useless presents to his friends.
To do all this he has to dig into his capital. But what of it? If
saving is a sin, dissaving must be a virtue; and in any case he is
simply making up for the harm being done by the saving of his
pinchpenny brother Benjamin.
It need hardly be said that Alvin is a great favorite with the
hat check girls, the waiters, the restaurateurs, the furriers, the
jewelers, the luxury establishments of all kinds. They regard
him as a public benefactor. Certainly it is obvious to everyone
that he is giving employment and spreading his money around.
Compared with him brother Benjamin is much less popular.
He is seldom seen at the jewelers, the furriers or the night
clubs, and he does not call the head waiters by their first names.
Whereas .Alvin spends not only the full $50,000 income each
year but is digging into capital besides, Benjamin lives much
more modestly and spends only about $25,000. Obviously,
think the people who see only what hits them in the eye, he is
providing less than half as much employment as Alvin, and the
other $25,000 is as useless as if it did not exist.
But let us see what Benjamin actually does with this other
$25,000. He does not let it pile up in his pocketbook, his bureau
drawers, or in his safe. He either deposits it in a bank or he
1Karl Rodbertus, Overproduction and, Crises (1850), p. 51.
invests it. If he puts it either into a commercial or a savings
bank, the bank either lends it to going businesses on short term
for working capital, or uses it to buy securities. In other words,
Benjamin invests his money either directly or indirectly. But
when money is invested it is used to buy or build capital
goods—houses or office buildings or factories or ships or trucks
or machines. Any one of these projects puts as much money
into circulation and gives as much employment as the same
amount of money spent directly on consumption.
"Saving," in short, in tbe modem world, is only another form of
spending. The usual difference is that the money is turned over
to someone else to spend on means to increase production. So
far as giving employment is concerned, Benjamin's "saving"
and spending combined give as much as Alvin's spending
alone, and put as much money in circulation. The chief difference
is that the employment provided by Alvin's spending can
be seen by anyone with one eye; but it is necessary to look a
little more carefully, and to think a moment, to recognize that
every dollar of Benjamin's saving gives as much employment as
every dollar that Alvin throws around.
A dozen years roll by. Alvin is broke. He is no longer seen in
the nightclubs and at the fashionable shops; and those whom he
formerly patronized, when they speak of him, refer to him as
something of a fool. He writes begging letters to Benjamin.
And Benjamin, who continues about the same ratio of spending
to saving, not only provides more jobs than ever, because his
income, through investment, has grown, but through his investment
he has helped to provide better-paying and more
productive jobs. His capital wealth and income are greater. He
has, in brief, added to the nation's productive capacity; Alvin
has not.
So many fallacies have grown up about saving in recent years
that they cannot all be answered by our example of the two
brothers. It is necessary to devote some further space to them.
Many stem from confusions so elementary as to seem incredible,
particularly when found in the works of economic writers
of wide repute. The word saving, for example, is used sometimes
to mean mere hoarding of money, and sometimes to mean
investment, with no clear distinction, consistently maintained,
between the two uses.
Mere hoarding of hand-to-hand money, if it takes place
irrationally, causelessly, and on a large scale, is in most
economic situations harmful. But this sort of hoarding is extremely
rare. Something that looks like this, but should be
carefully distinguished from it, often occurs after a downturn in
business has got under way. Consumptive spending and investment
are then both contracted. Consumers reduce their
buying. They do this partly, indeed, because they fear they
may lose their jobs, and they wish to conserve their resources:
they have contracted their buying not because they wish to
consume less but because they wish to make sure that their
power to consume will be extended over a longer period if they
do lose their jobs.
But consumers reduce their buying for another reason.
Prices of goods have probably fallen, and they fear a further
fall. If they defer spending, they believe they will get more for
their money. They do not wish to have their resources in goods
that are falling in value, but in money which they expect
(relatively) to rise in value.
The same expectation prevents them from investing. They
have lost their confidence in the profitability of business; or at
least they believe that if they wait a few months they can buy
stocks or bonds cheaper. We may think of them either as
refusing to hold goods that may fall in value on their hands, or
as holding money itself for a rise.
It is a misnomer to call this temporary refusal to buy "saving."
It does not spring from the same motives as normal
saving. And it is a still more serious error to say that this sort of
"saving" is the cause of depressions. It is, on the contrary, the
consequence of depressions.
It is true that this refusal to buy may intensify and prolong a
depression. At times when there is capricious government
intervention in business, and when business does not know
what the government is going to do next, uncertainty is created.
Profits are not reinvested. Firms and individuals allow cash
balances to accumulate in their banks. They keep larger reserves
against contingencies. This hoarding of cash may seem
like a cause of a subsequent slowdown in business activity. The
real cause, however, is the uncertainty brought about by the
government policies. The larger cash balances of firms and
individuals are merely one link in the chain of consequences
from that uncertainty. To blame "excessive saving" for the
business decline would be like blaming a fall in the price of
apples not on a bumper crop but on the people who refuse to
pay more for apples.
But when once people have decided to deride a practice or an
institution, any argument against it, no matter how illogical, is
considered good enough. It is said that the various consumers'
goods industries are built on the expectation of a certain demand,
and that if people take to saving they will disappoint this
expectation and start a depression. This assertion rests primarily
on the error we have already examined—that of forgetting
that what is saved on consumers' goods is spent on capital
goods, and that "saving" does not necessarily mean even a
dollar's contraction in total spending. The only element of truth
in the contention is that any change that is sudden may be
unsettling. It would be just as unsettling if consumers suddenly
switched their demand from one consumers' good to another. It
would be even more unsettling if former savers suddenly
switched their demand from capital goods to consumers' goods.
Still another objection is made against saving. It is said to be
just downright silly. The nineteenth century is derided for its
supposed inculcation of the doctrine that mankind through
saving should. go on baking itself a larger and larger cake
without ever eating the cake. This picture of the process is itself
naive and childish. It can best be disposed of, perhaps, by
putting before ourselves a somewhat more realistic picture of
what actually takes place.
Let us picture to ourselves, then, a nation that collectively
saves every year about 20 percent of all it produces in that year.
This figure greatly overstates the amount of net saving that has
occurred historically in the United States,2 but it is a round
figure that is easily handled, and it gives the benefit of every
doubt to those who believe that we have been "oversaving."
Bow as a result of this annual saving and investment, the
total annual production of the country will increase each year.
(To isolate the problem we are ignoring for the moment booms,
slumps, or other fluctuations.) Let us say that this annual
increase in production is 2.5 percentage points. (Percentage
points are taken instead of a compounded percentage merely to
simplify the arithmetic.)
2 Historically 20 percent would represent approximately the gross amount of
the gross national product devoted each year to capital formation (excluding
consumers' equipment). When allowance is made for capital consumption,
however, net annual savings have been closer to 12 percent. Cf. George
Terborgh, The Bogey of Economic Maturity (1945). For 1977 gross private
domestic investment was officially estimated at 16 percent of the gross
national product.
The first thing to be noticed about this table is that total
production increases each year because of the saving, and would
not have increased without it. (It is possible no doubt to imagine
that improvements and new inventions merely in replaced
machinery and other capital goods of a value no greater than the
old would increase the national productivity; but this increase
would amount to very little and the argument in any case
assumes enough prior investment to have made the existing
machinery possible.) The saving has been used year after year
to increase the quantity or improve the quality of existing
machinery, and so to increase the nation's output of goods.
There is, it is true (if that for some strange reason is considered
an objection), a larger and larger "cake" each year. Each year, it
is true, not all of the currently produced cake is consumed. But
there is no irrational or cumulative restraint. For each year a
larger and larger cake is in fact consumed; until, at the end of
eleven years (in our illustration), the annual consumers' cake
alone is equal to the combined consumers' and producers' cakes
of the first year. Moreover, the capital equipment, the ability to
produce goods, is itself 25 percent greater than in the first year.
Let us observe a few other points. The fact that 20 percent of
the national income goes each year for saving does not upset the
consumers' goods industries in the least. If they sold only the 80
units they produced in the first year (and there were no rise in
prices caused by unsatisfied demand) they would certainly not
be foolish enough to build their production plans on the assumption
that they were going to sell 100 units in the second
year. The consumers' goods industries, in other words, are
already geared to the assumption that the past situation in regard
to the rate of savings will continue. Only an unexpected sudden
and substantial increase in savings would unsettle them and leave
them with unsold goods.
But the same unsettlement, as we have already observed,
would be caused in the capital goods industries by a sudden and
substantial decrease in savings. If money that would previously
have been used for savings were thrown into the purchase of
consumers' goods, it would not increase employment but
merely lead to an increase in the price of consumption goods
and to a decrease in the price of capital goods. Its first effect on
net balance would be to force shifts in employment and temporarily
to decrease employment by its effect on the capital goods
industries. And its long-run effect would be to reduce production
below the level that would otherwise have been achieved.
The enemies of saving are not through. They begin by
drawing a distinction, which is proper enough, between "savings"
and "investment." But then they start to talk as if the two
were independent variables and as if it were merely an accident
that they should ever equal each other. These writers paint a
portentous picture. On the one side are savers automatically,
pointlessly, stupidly continuing to save; on the other side are
limited "investment opportunities" that cannot absorb this saving.
The result, alas, is stagnation. The only solution, they
declare, is for the government to expropriate these stupid and
harmful savings and to invent its own projects, even if these are
only useless ditches or pyramids, to use up the money and
provide employment.
There is so much that is false in this picture and "solution"
that we can here point only to some of the main fallacies.
Savings can exceed investment only by the amounts that are
actually hoarded in cash.3 Few people nowadays, in a modern
industrial community, hoard coins and bills in stockings or
under mattresses. 'To the small extent that this may occur, it
has already been reflected in the production plans of business
and in the price level. It is not ordinarily even cumulative:
3Many of the differences between economists in the diverse views now
expressed on this subject are merely the result of differences in definition.
Savings and investment may be so defined as to be identical, and therefore
necessarily equal. Here I am choosing to define savings in terms of money and
investment in terms of goods. This corresponds roughly with the common
use of the words, which is, however, not consistent.
dishoarding, as eccentric recluses die and their hoards are .
discovered and dissipated, probably offsets new hoarding. In
fact, the whole amount involved is probably insignificant in its
effect on business activity.
If money is kept either in savings banks or commercial banks,
as we have already seen, the banks are eager to lend and invest
it. They cannot afford to have idle funds. The only thing that
will cause people generally to try to increase their holdings of
cash, or that will cause banks to hold funds idle and lose the
interest on them, is, as we have seen, either fear that prices of
goods are going to fall or the fear of banks that they will be
taking too great a risk with their principal. But this means that
signs of a depression have already appeared, and have caused
the hoarding, rather than that the hoarding has started the
depression.
Apart from this negligible hoarding of cash, then (and even
this exception might be thought of as a direct "investment" in
money itself) savings and investment are brought into equilibrium
with each other in the same way that the supply of and
demand for any commodity are brought into equilibrium. For
we may define savings and investment as constituting respectively
the supply of and demand for new capital. And just as the
supply of and demand for any other commodity are equalized
by price, so the supply of and demand for capital are equalized
by interest rates. The interest rate is merely the special name
for the price of loaned capital. It is a price like any other.
This whole subject has been so appallingly confused in recent
years by complicated sophistries and disastrous governmental
policies based upon them that one almost despairs of
getting back to common sense and sanity about it. There is a
psychopathic fear of "excessive7' interest rates. It is argued that
if interest rates are too high it will not be profitable for industry
to borrow and invest in new plants and machines. This argument
has been so effective that governments everywhere in
recent decades have pursued artificial "cheap-money" policies.
But the argument, in its concern with increasing the demand
for capital, overlooks the effect of these policies on the supply of
capital. It is one more example of the fallacy of looking at the
effects of a policy only on one group and forgetting the effects
on another.
If interest rates are artificially kept too low in relation to
risks, there will be a reduction in both saving and lending. The
cheap-money proponents believe that saving goes on automatically,
regardless of the interest rate, because the sated rich have
nothing else that they can do with their money. They do not
stop to tell us at precisely what personal income level a man
saves a fixed minimum amount regardless of the rate of interest
or the risk at which he can lend it.
The fact is that, though the volume of saving of the very rich
is doubtless affected much less proportionately than that of the
moderately well-off by changes in the interest rate, practically
everyone's saving is affected in some degree. To argue, on the
basis of an extreme example, that the volume of real savings
would not be reduced by a substantial reduction in the interest
rate, is like arguing that the total production of sugar would not
be reduced by a substantial fall of its price because the efficient,
low-cost producers would still raise as much as before. The
argument overlooks the marginal saver, and even, indeed, the
great majority of savers.
The effect of keeping interest rates artificially low, in fact, is
eventually the same as that of keeping any other price below the
natural market. It increases demand and reduces supply. It
increases the demand for capital and reduces the supply of real
capital. It creates economic distortions. It is true, no doubt,
that an artificial reduction in the interest rate encourages increased
borrowing. It tends, in fact, to encourage highly
speculative ventures that cannot continue except under the
artificial conditions that gave them birth. On the supply side,
the artificial reduction of interest rates discourages normal
thrift, saving, and investment. It reduces the accumulation of
capital. It slows down that increase in productivity, that
"economic growth," that "progressives" profess to be so eager
to promote.
The money rate can, indeed, be kept artificially low only by
continuous new injections of currency or bank credit in place of
real savings. This can create the illusion of more capital just as
the addition of water can create the illusion of more milk. But it
is a policy of continuous inflation. It is obviously a process
involving cumulative danger. The money rate will rise and a
crisis will develop if the inflation is reversed, or merely brought
to a halt, or even continued at a diminished rate.
It remains to be pointed out that while new injections of
currency or bank credit can at first, and temporarily, bring
about lower interest rates, persistence in this device must eventually
raise interest rates. It does so because new injections of
money tend to lower the purchasing power of money. Lenders
then come to realize that the money they lend today will buy
less a year from now, say, when they get it back. Therefore to
the normal interest rate they add a premium to compensate
them for this expected loss in their money's purchasing power.
This premium can be high, depending on the extent of the
expected inflation. Thus the annual interest rate on British
treasury bills rose to 14 percent in 1976; Italian government
bonds yielded 16 percent in 1977; and the discount rate of the
central bank of Chile soared to 75 percent in 1974. Cheapmoney
policies, in short, eventually bring about far more violent
oscillations in business than those they are designed to
remedy or prevent.
If no effort is made to tamper with money rates through
inflationary governmental policies, increased savings create
their own demand by lowering interest rates in a natural manner.
The greater supply of savings seeking investment forces
savers to accept lower rates. But lower rates also mean that
more enterprises can afford to borrow because their prospective
profit on the new machines or plants they buy with the proceeds
seems likely to exceed what they have to pay for the
borrowed funds.
We come now to the last fallacy about saving with which I
intend to deal. This is the frequent assumption that there is a
fixed limit to the amount of new capital that can be absorbed, or
even that the limit of capital expansion has already been
reached. It is incredible that such a view could prevail even
among the ignorant, let alone that it could be held by any
trained economist. Almost the whole wealth of the modern
world, nearly everything that distinguishes it from the preindustrial
world of the seventeenth century, consists of its
accumulated capital.
This capital is made up in part of many things that might
better be called consumers' durable goods — automobiles, refrigerators,
furniture, schools, colleges, churches, libraries,
hospitals and above all private homes. Never in the history
of the world has there been enough of these. Even if there
were enough homes from a purely numerical point of view,
qualitative improvements are possible and desirable without
definite limit in all but the very best houses.
The second part of capital is what we may call capital proper.
It consists of the tools of production, including everything from
the crudest axe, knife or plow to the finest machine tool, the
greatest electric generator or cyclotron, or the most wonderfully
equipped factory. Here, too, quantitatively and especially
qualitatively, there is no limit to the expansion that is possible
and desirable. There will not be a "surplus" of capital until the
most backward country is as well equipped technologically as
the most advanced, until the most inefficient factory in
America is brought abreast of the factory with the latest and
finest equipment, and until the most modern tools of production
have reached a point where human ingenuity is at a dead
end, and can improve them no further. As long as any of these
conditions remains unfulfilled, there will be indefinite room
for more capital.
Hut how can the additional capital be "absorbed"? How can
it be "paid for"? If it is set aside and saved, it will absorb itself
and pay for itself. For producers invest in new capital
goods—that is, they buy new and better and more ingenious
tools—because these tools reduce costs of production. They either
bring into existence goods that completely unaided hand labor
could not bring into existence at all (and this now includes most
of the goods around us—books, typewriters, automobiles,
locomotives, suspension bridges); or they increase enormously
the quantities in which these can be produced; or (and this is
merely saying these things in a different way) they reduce unit
costs of production. And as there is no assignable limit to the
extent to which unit costs of production can be reduced — until
everything can be produced at no cost at all—there is no assignable
limit to the amount of new capital that can be absorbed.
The steady reduction of unit costs of production by the
addition of new capital does either one of two things, or both. It
reduces the costs of goods to consumers, and it increases the
wages of the labor that uses the new equipment because it
increases the productive power of that labor. Thus a new
machine benefits both the people who work on it directly and
the great body of consumers. In the case of consumers we may
say either that it supplies them with more and better goods for
the same money, or, what is the same thing, that it increases
their real incomes. In the case of the workers who use the new
machines it increases their real wages in a double way by
increasing their money wages as well. A typical illustration is
the automobile business. The American automobile industry
pays the highest wages in the world, and among the very
highest even in America. Yet (until about 1960) American
motorcar makers could undersell the rest of the world, because
their unit cost was lower. And the secret was that the capital
used in making American automobiles was greater per worker
and per car than anywhere else in the world.
And yet there are people who think we have reached the end
of this process,4 and still others who think that even if we
4For a statistical refutation of this fallacy consult George Terborgh, The
Bogey of Economic Maturity (1945). The "stagnationists" whom Dr. Terhorgh
was refuting have been succeeded by the Galbraithians with a similar doctrine.
haven't, the world is foolish to go on saving and adding to its
stock of capital.
It should not be difficult to decide, after our analysis, with
whom the real folly lies.
(It is true that the U.S. has been losing its world economic
leadership in recent years, but because of our own anticapitalist
governmental policies, not because of "economic maturity.")
FROM TIME IMMEMORIAL proverbial wisdom has taught the virtues
of saving, and warned against the consequences of prodigality
and waste. This proverbial wisdom has reflected the common
ethical as well as the merely prudential judgments of
mankind. But there have always been squanderers, and there
have apparently always been theorists to rationalize their
squandering.
The classical economists, refuting the fallacies of their own
day, showed that the saving policy that was in the best interests
of the individual was also in the best interests of the nation.
They showed that the rational saver, in making provision for
his future, was not hurting, but helping, the whole community.
But today the ancient virtue of thrift, as well as its defense
by the classical economists, is once more under attack, for
allegedly new reasons, while the opposite doctrine of spending
is in fashion.
In order to make the fundamental issue as clear as possible,
we cannot do better, I think, than to start with the classic
example used by Bastiat. Let us imagine two brothers, then,
one a spendthrift and the other a prudent man, each of whom
has inherited a sum to yield him an income of $50,000 a year.
We shall disregard the income tax, and the question whether
both brothers really ought to work for a living or give most of
their income to charity, because such questions are irrelevant to
our present purpose.
Alvin, then, the first brother, is a lavish spender. He spends
not only by temperament, but on principle. He is a disciple (to
go no further back) of Rodbertus, who declared in the middle of
the nineteenth century that capitalists "must expend their income
to the last penny in comforts and luxuries," for if they
"determine to save . . . goods accumulate, and part of the
workmen will have no work."1 Alvin is always seen at the night
clubs; he tips handsomely; he maintains a pretentious establishment,
with plenty of servants; he has a couple of chauffeurs,
and doesn't stint himself in the number of cars he owns; he
keeps a racing stable; he runs a yacht; he travels; he loads his
wife down with diamond bracelets and fur coats; he gives
expensive and useless presents to his friends.
To do all this he has to dig into his capital. But what of it? If
saving is a sin, dissaving must be a virtue; and in any case he is
simply making up for the harm being done by the saving of his
pinchpenny brother Benjamin.
It need hardly be said that Alvin is a great favorite with the
hat check girls, the waiters, the restaurateurs, the furriers, the
jewelers, the luxury establishments of all kinds. They regard
him as a public benefactor. Certainly it is obvious to everyone
that he is giving employment and spreading his money around.
Compared with him brother Benjamin is much less popular.
He is seldom seen at the jewelers, the furriers or the night
clubs, and he does not call the head waiters by their first names.
Whereas .Alvin spends not only the full $50,000 income each
year but is digging into capital besides, Benjamin lives much
more modestly and spends only about $25,000. Obviously,
think the people who see only what hits them in the eye, he is
providing less than half as much employment as Alvin, and the
other $25,000 is as useless as if it did not exist.
But let us see what Benjamin actually does with this other
$25,000. He does not let it pile up in his pocketbook, his bureau
drawers, or in his safe. He either deposits it in a bank or he
1Karl Rodbertus, Overproduction and, Crises (1850), p. 51.
invests it. If he puts it either into a commercial or a savings
bank, the bank either lends it to going businesses on short term
for working capital, or uses it to buy securities. In other words,
Benjamin invests his money either directly or indirectly. But
when money is invested it is used to buy or build capital
goods—houses or office buildings or factories or ships or trucks
or machines. Any one of these projects puts as much money
into circulation and gives as much employment as the same
amount of money spent directly on consumption.
"Saving," in short, in tbe modem world, is only another form of
spending. The usual difference is that the money is turned over
to someone else to spend on means to increase production. So
far as giving employment is concerned, Benjamin's "saving"
and spending combined give as much as Alvin's spending
alone, and put as much money in circulation. The chief difference
is that the employment provided by Alvin's spending can
be seen by anyone with one eye; but it is necessary to look a
little more carefully, and to think a moment, to recognize that
every dollar of Benjamin's saving gives as much employment as
every dollar that Alvin throws around.
A dozen years roll by. Alvin is broke. He is no longer seen in
the nightclubs and at the fashionable shops; and those whom he
formerly patronized, when they speak of him, refer to him as
something of a fool. He writes begging letters to Benjamin.
And Benjamin, who continues about the same ratio of spending
to saving, not only provides more jobs than ever, because his
income, through investment, has grown, but through his investment
he has helped to provide better-paying and more
productive jobs. His capital wealth and income are greater. He
has, in brief, added to the nation's productive capacity; Alvin
has not.
So many fallacies have grown up about saving in recent years
that they cannot all be answered by our example of the two
brothers. It is necessary to devote some further space to them.
Many stem from confusions so elementary as to seem incredible,
particularly when found in the works of economic writers
of wide repute. The word saving, for example, is used sometimes
to mean mere hoarding of money, and sometimes to mean
investment, with no clear distinction, consistently maintained,
between the two uses.
Mere hoarding of hand-to-hand money, if it takes place
irrationally, causelessly, and on a large scale, is in most
economic situations harmful. But this sort of hoarding is extremely
rare. Something that looks like this, but should be
carefully distinguished from it, often occurs after a downturn in
business has got under way. Consumptive spending and investment
are then both contracted. Consumers reduce their
buying. They do this partly, indeed, because they fear they
may lose their jobs, and they wish to conserve their resources:
they have contracted their buying not because they wish to
consume less but because they wish to make sure that their
power to consume will be extended over a longer period if they
do lose their jobs.
But consumers reduce their buying for another reason.
Prices of goods have probably fallen, and they fear a further
fall. If they defer spending, they believe they will get more for
their money. They do not wish to have their resources in goods
that are falling in value, but in money which they expect
(relatively) to rise in value.
The same expectation prevents them from investing. They
have lost their confidence in the profitability of business; or at
least they believe that if they wait a few months they can buy
stocks or bonds cheaper. We may think of them either as
refusing to hold goods that may fall in value on their hands, or
as holding money itself for a rise.
It is a misnomer to call this temporary refusal to buy "saving."
It does not spring from the same motives as normal
saving. And it is a still more serious error to say that this sort of
"saving" is the cause of depressions. It is, on the contrary, the
consequence of depressions.
It is true that this refusal to buy may intensify and prolong a
depression. At times when there is capricious government
intervention in business, and when business does not know
what the government is going to do next, uncertainty is created.
Profits are not reinvested. Firms and individuals allow cash
balances to accumulate in their banks. They keep larger reserves
against contingencies. This hoarding of cash may seem
like a cause of a subsequent slowdown in business activity. The
real cause, however, is the uncertainty brought about by the
government policies. The larger cash balances of firms and
individuals are merely one link in the chain of consequences
from that uncertainty. To blame "excessive saving" for the
business decline would be like blaming a fall in the price of
apples not on a bumper crop but on the people who refuse to
pay more for apples.
But when once people have decided to deride a practice or an
institution, any argument against it, no matter how illogical, is
considered good enough. It is said that the various consumers'
goods industries are built on the expectation of a certain demand,
and that if people take to saving they will disappoint this
expectation and start a depression. This assertion rests primarily
on the error we have already examined—that of forgetting
that what is saved on consumers' goods is spent on capital
goods, and that "saving" does not necessarily mean even a
dollar's contraction in total spending. The only element of truth
in the contention is that any change that is sudden may be
unsettling. It would be just as unsettling if consumers suddenly
switched their demand from one consumers' good to another. It
would be even more unsettling if former savers suddenly
switched their demand from capital goods to consumers' goods.
Still another objection is made against saving. It is said to be
just downright silly. The nineteenth century is derided for its
supposed inculcation of the doctrine that mankind through
saving should. go on baking itself a larger and larger cake
without ever eating the cake. This picture of the process is itself
naive and childish. It can best be disposed of, perhaps, by
putting before ourselves a somewhat more realistic picture of
what actually takes place.
Let us picture to ourselves, then, a nation that collectively
saves every year about 20 percent of all it produces in that year.
This figure greatly overstates the amount of net saving that has
occurred historically in the United States,2 but it is a round
figure that is easily handled, and it gives the benefit of every
doubt to those who believe that we have been "oversaving."
Bow as a result of this annual saving and investment, the
total annual production of the country will increase each year.
(To isolate the problem we are ignoring for the moment booms,
slumps, or other fluctuations.) Let us say that this annual
increase in production is 2.5 percentage points. (Percentage
points are taken instead of a compounded percentage merely to
simplify the arithmetic.)
2 Historically 20 percent would represent approximately the gross amount of
the gross national product devoted each year to capital formation (excluding
consumers' equipment). When allowance is made for capital consumption,
however, net annual savings have been closer to 12 percent. Cf. George
Terborgh, The Bogey of Economic Maturity (1945). For 1977 gross private
domestic investment was officially estimated at 16 percent of the gross
national product.
The first thing to be noticed about this table is that total
production increases each year because of the saving, and would
not have increased without it. (It is possible no doubt to imagine
that improvements and new inventions merely in replaced
machinery and other capital goods of a value no greater than the
old would increase the national productivity; but this increase
would amount to very little and the argument in any case
assumes enough prior investment to have made the existing
machinery possible.) The saving has been used year after year
to increase the quantity or improve the quality of existing
machinery, and so to increase the nation's output of goods.
There is, it is true (if that for some strange reason is considered
an objection), a larger and larger "cake" each year. Each year, it
is true, not all of the currently produced cake is consumed. But
there is no irrational or cumulative restraint. For each year a
larger and larger cake is in fact consumed; until, at the end of
eleven years (in our illustration), the annual consumers' cake
alone is equal to the combined consumers' and producers' cakes
of the first year. Moreover, the capital equipment, the ability to
produce goods, is itself 25 percent greater than in the first year.
Let us observe a few other points. The fact that 20 percent of
the national income goes each year for saving does not upset the
consumers' goods industries in the least. If they sold only the 80
units they produced in the first year (and there were no rise in
prices caused by unsatisfied demand) they would certainly not
be foolish enough to build their production plans on the assumption
that they were going to sell 100 units in the second
year. The consumers' goods industries, in other words, are
already geared to the assumption that the past situation in regard
to the rate of savings will continue. Only an unexpected sudden
and substantial increase in savings would unsettle them and leave
them with unsold goods.
But the same unsettlement, as we have already observed,
would be caused in the capital goods industries by a sudden and
substantial decrease in savings. If money that would previously
have been used for savings were thrown into the purchase of
consumers' goods, it would not increase employment but
merely lead to an increase in the price of consumption goods
and to a decrease in the price of capital goods. Its first effect on
net balance would be to force shifts in employment and temporarily
to decrease employment by its effect on the capital goods
industries. And its long-run effect would be to reduce production
below the level that would otherwise have been achieved.
The enemies of saving are not through. They begin by
drawing a distinction, which is proper enough, between "savings"
and "investment." But then they start to talk as if the two
were independent variables and as if it were merely an accident
that they should ever equal each other. These writers paint a
portentous picture. On the one side are savers automatically,
pointlessly, stupidly continuing to save; on the other side are
limited "investment opportunities" that cannot absorb this saving.
The result, alas, is stagnation. The only solution, they
declare, is for the government to expropriate these stupid and
harmful savings and to invent its own projects, even if these are
only useless ditches or pyramids, to use up the money and
provide employment.
There is so much that is false in this picture and "solution"
that we can here point only to some of the main fallacies.
Savings can exceed investment only by the amounts that are
actually hoarded in cash.3 Few people nowadays, in a modern
industrial community, hoard coins and bills in stockings or
under mattresses. 'To the small extent that this may occur, it
has already been reflected in the production plans of business
and in the price level. It is not ordinarily even cumulative:
3Many of the differences between economists in the diverse views now
expressed on this subject are merely the result of differences in definition.
Savings and investment may be so defined as to be identical, and therefore
necessarily equal. Here I am choosing to define savings in terms of money and
investment in terms of goods. This corresponds roughly with the common
use of the words, which is, however, not consistent.
dishoarding, as eccentric recluses die and their hoards are .
discovered and dissipated, probably offsets new hoarding. In
fact, the whole amount involved is probably insignificant in its
effect on business activity.
If money is kept either in savings banks or commercial banks,
as we have already seen, the banks are eager to lend and invest
it. They cannot afford to have idle funds. The only thing that
will cause people generally to try to increase their holdings of
cash, or that will cause banks to hold funds idle and lose the
interest on them, is, as we have seen, either fear that prices of
goods are going to fall or the fear of banks that they will be
taking too great a risk with their principal. But this means that
signs of a depression have already appeared, and have caused
the hoarding, rather than that the hoarding has started the
depression.
Apart from this negligible hoarding of cash, then (and even
this exception might be thought of as a direct "investment" in
money itself) savings and investment are brought into equilibrium
with each other in the same way that the supply of and
demand for any commodity are brought into equilibrium. For
we may define savings and investment as constituting respectively
the supply of and demand for new capital. And just as the
supply of and demand for any other commodity are equalized
by price, so the supply of and demand for capital are equalized
by interest rates. The interest rate is merely the special name
for the price of loaned capital. It is a price like any other.
This whole subject has been so appallingly confused in recent
years by complicated sophistries and disastrous governmental
policies based upon them that one almost despairs of
getting back to common sense and sanity about it. There is a
psychopathic fear of "excessive7' interest rates. It is argued that
if interest rates are too high it will not be profitable for industry
to borrow and invest in new plants and machines. This argument
has been so effective that governments everywhere in
recent decades have pursued artificial "cheap-money" policies.
But the argument, in its concern with increasing the demand
for capital, overlooks the effect of these policies on the supply of
capital. It is one more example of the fallacy of looking at the
effects of a policy only on one group and forgetting the effects
on another.
If interest rates are artificially kept too low in relation to
risks, there will be a reduction in both saving and lending. The
cheap-money proponents believe that saving goes on automatically,
regardless of the interest rate, because the sated rich have
nothing else that they can do with their money. They do not
stop to tell us at precisely what personal income level a man
saves a fixed minimum amount regardless of the rate of interest
or the risk at which he can lend it.
The fact is that, though the volume of saving of the very rich
is doubtless affected much less proportionately than that of the
moderately well-off by changes in the interest rate, practically
everyone's saving is affected in some degree. To argue, on the
basis of an extreme example, that the volume of real savings
would not be reduced by a substantial reduction in the interest
rate, is like arguing that the total production of sugar would not
be reduced by a substantial fall of its price because the efficient,
low-cost producers would still raise as much as before. The
argument overlooks the marginal saver, and even, indeed, the
great majority of savers.
The effect of keeping interest rates artificially low, in fact, is
eventually the same as that of keeping any other price below the
natural market. It increases demand and reduces supply. It
increases the demand for capital and reduces the supply of real
capital. It creates economic distortions. It is true, no doubt,
that an artificial reduction in the interest rate encourages increased
borrowing. It tends, in fact, to encourage highly
speculative ventures that cannot continue except under the
artificial conditions that gave them birth. On the supply side,
the artificial reduction of interest rates discourages normal
thrift, saving, and investment. It reduces the accumulation of
capital. It slows down that increase in productivity, that
"economic growth," that "progressives" profess to be so eager
to promote.
The money rate can, indeed, be kept artificially low only by
continuous new injections of currency or bank credit in place of
real savings. This can create the illusion of more capital just as
the addition of water can create the illusion of more milk. But it
is a policy of continuous inflation. It is obviously a process
involving cumulative danger. The money rate will rise and a
crisis will develop if the inflation is reversed, or merely brought
to a halt, or even continued at a diminished rate.
It remains to be pointed out that while new injections of
currency or bank credit can at first, and temporarily, bring
about lower interest rates, persistence in this device must eventually
raise interest rates. It does so because new injections of
money tend to lower the purchasing power of money. Lenders
then come to realize that the money they lend today will buy
less a year from now, say, when they get it back. Therefore to
the normal interest rate they add a premium to compensate
them for this expected loss in their money's purchasing power.
This premium can be high, depending on the extent of the
expected inflation. Thus the annual interest rate on British
treasury bills rose to 14 percent in 1976; Italian government
bonds yielded 16 percent in 1977; and the discount rate of the
central bank of Chile soared to 75 percent in 1974. Cheapmoney
policies, in short, eventually bring about far more violent
oscillations in business than those they are designed to
remedy or prevent.
If no effort is made to tamper with money rates through
inflationary governmental policies, increased savings create
their own demand by lowering interest rates in a natural manner.
The greater supply of savings seeking investment forces
savers to accept lower rates. But lower rates also mean that
more enterprises can afford to borrow because their prospective
profit on the new machines or plants they buy with the proceeds
seems likely to exceed what they have to pay for the
borrowed funds.
We come now to the last fallacy about saving with which I
intend to deal. This is the frequent assumption that there is a
fixed limit to the amount of new capital that can be absorbed, or
even that the limit of capital expansion has already been
reached. It is incredible that such a view could prevail even
among the ignorant, let alone that it could be held by any
trained economist. Almost the whole wealth of the modern
world, nearly everything that distinguishes it from the preindustrial
world of the seventeenth century, consists of its
accumulated capital.
This capital is made up in part of many things that might
better be called consumers' durable goods — automobiles, refrigerators,
furniture, schools, colleges, churches, libraries,
hospitals and above all private homes. Never in the history
of the world has there been enough of these. Even if there
were enough homes from a purely numerical point of view,
qualitative improvements are possible and desirable without
definite limit in all but the very best houses.
The second part of capital is what we may call capital proper.
It consists of the tools of production, including everything from
the crudest axe, knife or plow to the finest machine tool, the
greatest electric generator or cyclotron, or the most wonderfully
equipped factory. Here, too, quantitatively and especially
qualitatively, there is no limit to the expansion that is possible
and desirable. There will not be a "surplus" of capital until the
most backward country is as well equipped technologically as
the most advanced, until the most inefficient factory in
America is brought abreast of the factory with the latest and
finest equipment, and until the most modern tools of production
have reached a point where human ingenuity is at a dead
end, and can improve them no further. As long as any of these
conditions remains unfulfilled, there will be indefinite room
for more capital.
Hut how can the additional capital be "absorbed"? How can
it be "paid for"? If it is set aside and saved, it will absorb itself
and pay for itself. For producers invest in new capital
goods—that is, they buy new and better and more ingenious
tools—because these tools reduce costs of production. They either
bring into existence goods that completely unaided hand labor
could not bring into existence at all (and this now includes most
of the goods around us—books, typewriters, automobiles,
locomotives, suspension bridges); or they increase enormously
the quantities in which these can be produced; or (and this is
merely saying these things in a different way) they reduce unit
costs of production. And as there is no assignable limit to the
extent to which unit costs of production can be reduced — until
everything can be produced at no cost at all—there is no assignable
limit to the amount of new capital that can be absorbed.
The steady reduction of unit costs of production by the
addition of new capital does either one of two things, or both. It
reduces the costs of goods to consumers, and it increases the
wages of the labor that uses the new equipment because it
increases the productive power of that labor. Thus a new
machine benefits both the people who work on it directly and
the great body of consumers. In the case of consumers we may
say either that it supplies them with more and better goods for
the same money, or, what is the same thing, that it increases
their real incomes. In the case of the workers who use the new
machines it increases their real wages in a double way by
increasing their money wages as well. A typical illustration is
the automobile business. The American automobile industry
pays the highest wages in the world, and among the very
highest even in America. Yet (until about 1960) American
motorcar makers could undersell the rest of the world, because
their unit cost was lower. And the secret was that the capital
used in making American automobiles was greater per worker
and per car than anywhere else in the world.
And yet there are people who think we have reached the end
of this process,4 and still others who think that even if we
4For a statistical refutation of this fallacy consult George Terborgh, The
Bogey of Economic Maturity (1945). The "stagnationists" whom Dr. Terhorgh
was refuting have been succeeded by the Galbraithians with a similar doctrine.
haven't, the world is foolish to go on saving and adding to its
stock of capital.
It should not be difficult to decide, after our analysis, with
whom the real folly lies.
(It is true that the U.S. has been losing its world economic
leadership in recent years, but because of our own anticapitalist
governmental policies, not because of "economic maturity.")
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