1.3.6 Saving

The concept of saving, defined as non-consumed income of the past, as a condition for investments is perhaps the most fundamental error in economic thinking, see value.

What should actually be understood is that the definition above, savings are not consumed incomes of the past, is wrong and that the right definition is this one: Saving is the production of capital goods instead of consumer goods. For more details, see the little book about Keynes downloadable from the start of this website.

In order to understand the Keynesian theory, there is no need to know all the different variations of this basic error, but actually, there are variations.

It is curious fact that very often a theory is not really refuted by arguments, but silently ignored and fading out in the course of time. To give a prominent example: In the Middle Age, the dominant subject was theology, but theology was dominated by scholasticism. Scholasticism was never really refuted; it just faded out. Nobody cares about anymore.

Jean-Baptiste Say and David Ricardo knew each other, their writings as well as personally, but they silently ignored the respective theories about saving. Jean-Baptiste Say didn't mention the theory of David Ricardo and David Ricardo didn't mention the theory of Jean-Baptiste Say.

For the understanding of the real world, there is no need to understand the differences between the different variations of this basic error. However, sometimes it is useful, if we want to understand why some public discussed ideas are misleading.

  1. For Jean-Baptiste Say, see the paragraph below, saving depends on the profit. If the profit is very low, people will stop saving and consume their money. Crisis due to underconsumption is, therefore, never possible. All the income is either consumed or invested. The logic of David Ricardo is different. The workmen consume all their income, because they eternally live at the subsistence level and have therefore no chance to save something. The capitalists invests all the added value generated by the workmen, independently from the interest rate.
  2. In the conception of David Ricardo savings, in the form of added value, derives solely from labour. In the conception of Jean-Baptiste Say, just any production factor including know-how can save part of its income. Savings can, therefore, be derived from labour, capital, land and know-how.
  3. Both suppose that saving is the condition for investment. Moreover, that savings can always be invested. However, there is a difference. In the case of David Ricardo actually any amount of saving, added value, can be invested. The only limit for investments is the amount of savings. Supply is always scarce and any amount of supply can be sold. In the case of Jean-Baptiste Say, the demand can theoretically lead to a reduction in savings and investments because all needs are satisfied. (See the paragraph below.)
  4. In the concept of Jean-Baptiste Say, more savings lead to more "capital", actually money for investment purposes, see interest rates, and more capital can only be absorbed by investments if the interest rates decrease. In the concept of David Ricardo, the profits decrease because the capitalists have to pay higher wages due to the increase in the prices of food.

It is, therefore, obvious that in both cases, saving being the condition for investments, is actually a very misleading concept, but we have two completely different versions of this error.

Si les profits des capitaux baissent à mesure qu'ils deviennent plus abondants, on peut se demander si, dans un pays éminemment industrieux et économe, les capitaux pourraient se multiplier au point que leurs profits se réduisissent à rien. Il est difficile de croire ce cas possible ; car plus les profits capitaux diminuent, et plus diminuent aussi les motifs qui portent les hommes à l'épargne. Il est évident que l'homme qui pourrait épargner une somme sur ses revenus la dépensera, si cette somme devient incapable d'être employée avec profit ; car après tout elle renferme en elle une source de jouissances, et il y a des jouissances inépuisables, comme celles qui prennent leur source dans des actes de bienfaisance et de munificence publiques. C'est aussi dans les pays industrieux et économes que de tels actes sont les plus fréquents. If the profits on capital decreases, if the amount of capital increases, one could asks oneself if an industrialised and developed country the amount of capital can reach a state where the profits are cero. This is difficult to imagine, because in the extent that the profits on capital decreases, the less people are induced to save. It is obvious that a man who can save a certain amount of money will spend this money if this amount of money can't be invested in a profitable way, because this amount of money contains a lot of pleasures which will never be fully satisfied as well as charity work and donations for the benefit of the public. This is why they are bigger in economically developed countries.

As we can see easily, there is a basic error in thinking in this paragraph: "...the amount of capital can reach a state where the profits are zero...". The error in thinking is that this point can be very easily reached because capital for investment purposes is actually money and money can be printed in any amount, see interest rates. Based on this erroneous assumption, he makes the next error in thinking: "...if this amount of money can't be invested in a profitable way because this amount of money contains a lot of pleasures which will never be fully satisfied...". He assumes that the money that is not invested can be consumed. That is actually true, but the tradeoff doesn't exist.

He assumes that capital, not consumed income of the past, can be either consumed or invested. This is true for a household or a company, for a single entity, BUT NOT FOR THE ECONOMY AS A WHOLE. From a macroeconomic point of view, people can consume all the money they have and finance their investments with loans. He assumes that loans can only be granted if someone else has saved money before. That's not true. The banking system can create money, in the worst case the central bank prints it, and the banking system doesn't need any saving to grant loans.

Furthermore, Jean-Baptiste Say believes that the interest rate equals savings and investments. That's not the case. To put it simply, the interest rate is fixed by the central bank and this has little to do with the supply and demand for "capital", actually money. He believes that the interest rate is a price in the sense of the market economy. That's not the case, see interest rates.

In the next chapter, we have a short description of the basic error.

Les capitaux de cette sorte se forment, comme tous les autres sans exception, par l'accumulation d'une partie des produits annuels. Il n'y a pas d'autre manière d'avoir des capitaux que de les accumuler soi-même, ou de les tenir de quelqu'un qui les a accumulés. Capital of this kind (productive capital) is generated, as any other capital accumulating a part of the anual products. There is no other way to obtain capital than by accumulating it oneself or by getting it from someone who had accumulated it.

Jean-Baptiste Say, Traité d’économie politique II, Chapitre XIII, Des produits immatériels, ou des valeurs qui sont consommées au moment de leur production

This logic is somehow weird even in the 18th century. In the classical theory, money is only needed for transaction purposes as Jean-Baptiste Say explains explicitly, see Law of Say. That means that in the case that the national income grows, the amount of money have to grow as well. It is difficult therefore to understand, how the national income can grow if the amount of money doesn't grow. For an unknown reason in the world of Jean-Baptiste Say and the other classical authors first the national income grows and the amount of money, by whatever method, follows the growth of the national income. The other way round is more logical. First the amount of money grows and then the national income. In other words, growth is financed by an increase in the amount of money.

Jean-Baptiste Say, like all the others classical authors has a microeconomic approach. He assumes that a rational behaviour from an individual perspective is rational as well from a macroeconomic point of view. That's not the case. A single individual becomes richer the more he saves, that's obvious. If he is the only one who saves and the central bank keeps the amount of money scarce, there will be opportunities to invest his saving and the recompensation for his sacrifice, the renunciation of consumption, will be high enough.

From a macroeconomic point of view, that doesn't work. If everybody saves, investments can't absorb these savings. The solution of the classics to this problem is simple: The more people save, the lower the interest rate and at a certain point people will stop saving because it is not worth the sacrifice gave the low-interest rates. We know from a practical point of view that this is not true because institutional investors have serious problems to invest the collected savings nowadays, we are still in 2015, and from a theoretical point of view the theory is not plausible, see the booklet downloadable from the start of this website.

The problem is not only that there is an alternative to consuming or save/invest, but that's also the problem addressed by Keynes. The problem is that saving is not even needed for investments in the case of unemployment, it is understood as idle productive resources.

The next paragraph contradicts any experience. First, the investors have very serious problems to detect real profitable investments. They have a very clear preference for investments in the stock markets where they produce most of all bubbles. Even the savings that are the result of the not consumed income of the past can be invested.

However, the situation is still more complicated. If it were so easy to find profitable investments, ideally until full employment is reached, they could be realised with MONEY. Something that can be printed at any amount. For more details see interest rates.

Tout entrepreneur d'industrie, faisant lui-même travailler son capital, trouve avec facilité les moyens d'occuper productivement ses épargnes. S'il est cultivateur, il achète des portions de terre, ou augmente par des bonifications le pouvoir productif de celles qu'il a. S'il est négociant, il achète et revend une plus grande masse de marchandises. Les capitalistes ont à peu près les mêmes moyens ; ils augmentent de tout le montant de leurs épargnes leur capital déjà placé, ou bien ils cherchent de nouveaux placements, pour eux d'autant plus faciles à trouver que, connus pour avoir des fonds à placer, ils reçoivent plus que d'autres des propositions pour l'emploi de leurs épargnes. Mais les propriétaires de terres affermées, et les personnes qui vivent de leurs rentes ou du salaire de leur main-d'oeuvre, n'ont pas la même facilité, et ne peuvent placer utilement un capital qu'autant qu'il se monte à une certaine somme. Beaucoup d'épargnes sont, par cette raison, consommées improductivement, qui auraient pu être consommées reproductivement, et grossir les capitaux particuliers, et par conséquent la somme du capital national. Les caisses et les associations qui se chargent de recevoir, de réunir et de faire valoir les petites épargnes des particuliers sont en conséquence (toutes les fois qu'elles offrent une sûreté parfaite) très favorables à la multiplication des capitaux. Any entrepreneur engaged in the industry who has his capital working for him finds without any problem, possibilities to invest his capital in a productive way. If he is a farmer, he will buy more land or increases by improving the productivity of those he already has. If he is a trader, he will buy and sell a greater amount of commodities. Capitalists have more or less the same possibilities. They increase their capital proportionally to their capital already invested or they look for new investments, something easy for them because everybody knows that they have funds to invest and therefore, they get propositions for the placement of their savings. But the landowners who have leased their land and people who live from their rent or off the wages paid for their labour don't have this opportunities and can't invest their capital if it doesn't exceed a certain amount. That's why a lot of savings that could have increased the individual capital and therefore, the capital of the nation, is consumed improductively. Savings banks and other associations who are engaged in getting, collecting and using productively, the small savings of the individuals are, therefore, (presumed that they offer guarantees) very favourable to the multiplication of capital.

Jean-Baptiste Say, Traité d’économie politique II, Chapitre XIII, Des produits immatériels, ou des valeurs qui sont consommées au moment de leur production

There are two main errors in this paragraph. The first error is that it is well possible that there is always an opportunity for investments, but the question is at what interest rates and in which period the loans are to be paid back. Investing in a building, for instance, yields income for 200 years or even more. There is no need for the living generation to pay back the loan at their time of living. The next generation will inherit debts and fortune, and the fortune will exceed the value of the debts if the living generation paid back, at least, part of the loan.

Jean-Baptiste Say mixes to different arguments, which are actually incompatible. In the first paragraph, he argues that people will stop saving if the recompensation for their savings is not strong enough. Now he argues that any kind of consumption is unproductive and should be used in a productive way. If that is true, then any investment in infrastructure, roads, bridges, canals, buildings, research and development would be beneficial, at leat in the long run. However, in order to allow this kind of investments, interest rates must be low and the payback period long.

However, that is not even the real problem. In case of idle productive resources, people can spend all the money they have and consume whatever they want. Investments can be financed by loans, and these loans can be granted without savings. Loans are handed over in the most liquid form, money, and money can be printed. The problem is, that in a situation of insecurity, where people don't find sure and profitable investments people won't take a loan. The problem is not whether there is or not enough "capital". The problem is, that the future is sometimes so insecure, that nobody is willing to take risks and to invest.

The problem is that Jean-Baptiste Say, as all the classical and neoclassical authors and all the lines of thinking based on classical/neoclassical concepts considers capital as a production factor without clearly defining what they mean by that. Capital in the sense of machines, building, raw materials are obviously "capital" in this sense. However, that is not needed for a new investment. For a new investment, MONEY is needed, and money is not the result of prior savings.

Besides that, most capital is know how. The production of know how doesn't follow a regular rate of accumulation. Sometimes there is no growth at all, as for example in the Middle Age, and sometimes there is an explosion of know how, as in the last 30 years. (We are still in 2015.) The production of know how is in part spontaneous depends on casualties and is therefore unpredictable.

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Consumption and investment can be financed by loans and a the possibility to grant loans doesn't depend on prior savings. Capital for investive purposes must be disposable in its most liquid form: money. In case of full employment an investor can reallocate resources with money. That's the issue addressed by Joseph Schumpeter. In a situation of unemployment, money can be used to activate idle resources.

Saving can be defined only in real terms. Saving is the production of capital goods instead of consumer goods. The definition wie find in textbooks, saving as not consumed incomes of the past, is misleading. Only the first definition addresses a real existing trade off. In a situation of full employment a decision is to be made in favour of the production of capital goods or the production of consumer goods. That is the only relevant context where saving is needed.

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