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One characteristic of public policy debate is that discussing what the effects of a policy are is really discussing two different futures:

If we do this in 2011, here is the 2012 we will have.

If we do that in 2011, we will have this other 2012.

We tend to think of a single action in the past as having caused a situation in the present, not of a choice having altered the situation. Reactionaries take advantage of that tendency. "See! After the Bush tax cuts the economy grew. Therefore the economy grew because of the Bush tax cuts." In truth, after the Bush tax cuts the economy grew at a record slow pace. (There have been three presidential terms since 1948 in which RGDP grew less than 10% over the entire four years. All of them had a President Bush.) The question is what growth would have been likely in the absence of these cuts. Certainly, 'no growth' is a ridiculous assumption.

I got caught making a similar simplification in a previous diary. Let me state the issue more correctly after the jump.

I got caught making a similar simplification in a previous diary. Let me state the issue more correctly. Instead of dealing with the consequences of saving -- that is, of not consuming -- on investment, I treated an act of consumption as if it were done in time. I assumed that everybody would understand that the consequences of savings were the opposite of the consequences of consumption. Several commentors did not.

In a closed economy, savings is always equal to the investment in plant, equipment, and inventory. That follows from the consideration that every time an article is produced, there is produced an equal claim on production. (I'm not saying that the claims are distibuted fairly, merely that they are distributed.) Some of the claims go to government, which expends them; some of the claims are used for consumption of consumption goods; The rest is saved.

Some of the production is used by government; some of it is consumed[ some of it is invested in new plant and equipment.  The rest goes into inventory. Since the amount of the claims going to bovernment purchases is the same as the production used by government, and the amount of production going into consumption is the same as the claims on production used in consumption, then simple arithemetic demonstrates that the claims saved equals the investment in plant and equipment and the increase in inventory.

To keep this arithmetical equality, there are only a few requirements:

  1. Everything must be counted in the same way at every stage. If a pear rots before it is eaten, then either it must be counted as not produced or it must be counted as consumed. You can't write down inventory unless you take it out of something else.
  1. You must allow negative numbers. If widgets are not produced but are consumed, then the change in widget inventory is negative. The governement can save, and the savings of government can be (usually are, in aggregate) negative. When the educated talk of negative savings or negative growth, there is always some ignoramus who objects. Those who flunked HS algebra and don't know how to add negative numbers should read Dick and Jane rather than this diary.
  1. "Savings" ain't just what you put in your savings account. It is (net) income not spent on consumption. There are three ways to produce technical terms to add to the professional vocabulary, and all three give problems. Economists use many a common term in a specialized, narrow, sense. (If you don't like that, study physics. They use "newton" and "fermion" as terms. You don't have any conflicting, old, definitions of those rattling around your skull.)

The USA is not quite a closed system. We can close it for the purposes of our analysis by lumping together "our trading partners." These take our net exports (our exports minus our imports) and our net cash flow (the money we send overseas minus the money which comes from overseas). Put that fictitious collective in with us, and you get a closed system. Actually, it matters less than some people think for purposes of policy analysis. Our trading partners mske dicsions for their own reasons; it's dubious that a change in our policies will change their behavior dramatically.

Anyway, total savings always equals total investment in plant, equipment, and inventory in a closed society. The question is what will be the effect of encouraging saving. The first thing to realize is that saving = investment = production - government - consumption. If someone chooses to save rather than consume (which is the choice we are talking about), then this increases investment only if production is unchanged.

The second thing to realize is that, while I've put this in a huge macroeconomic context, it's an areithmetical identity. That means that it can be considered in as instantaneous and as small a situation as one wishes. Take one:

Jones has a widget store. He has widgets in stock for which he paid $60 each. He's selling them for $100. Smith decides whether to buy one or not. His only decision right then is to buy a widget or save the money. (Remember that his savings is the money that he doesn't spend on consumption.)

If Smith decides to consume, his savings goes down $100, Jones's inventory goes down $60, and Jones's savings goes up $40. (We are considering only the instant that contains this transaction. Jones doesn't have time to consume that $40.) Total savings go down $100 - $40 = $60. Total investment in inventory goes down $60. Total investment in plant and equipment is unchanged.

If Smith decides to save (that is, to not consume that widget), then everything is unchanged.

That is to say that compared to the alternative the desire to save results in $60 more savings, $60 more investment in inventory, and no change in the investment in plant and equipment.

Note that it is only in such comparisons -- sideways in time, so to speak -- that saving is an action at all. Otherwise, it is an inaction. Note also that the consumption (and, therefore, the alernative saving) was the same whether Smith paid by bills pulled from his wallet, by check, or by credit card. (Not going deeper into debt is a saving, just as going from - 10  degrees  to - 5 degrees is an increase in temperature.) Common understanding can be somewhat different: "I'll spend to mooney in my wallet, but not the money in my cookie jar; so when I take money from my wallet to put in the cookie jar, I'm saving." That's not the economic sense of the term.

Now, the action of one consumer will be lost in the "noise" (in the information-theory sense) of commercial activity. We have to aggregate this to see the economic impact of greater saving. It is necesary, however, to aggregate everything to arrive at a clear understanding. One of the greatest causes of misunderstanding of academic subjects is aggregating one aspect and saying that another can be ignored -- which it can in the individual case -- and, so, getting an imbalance where there is really a balance.

So, let's go back. A simple decision to save $100 rather than buy a $100 widget leaves the total investment in inventory $60 larger and total savings $60 larger than the alternative. (Buying yhr widget.) It has no immediate effect on investment in plant and equipment. What happens if a million such decisions are made? (I'm assuming the decsion to save $100.000,000 -- not necessarily all on widgets, but all on consumer goods.) The first effects are a $60,000,000 increase in savings and a $60,000,000 increase in inventory for retailers. Now, as time goes on, the retailers will decrease their orders from the wholesalers, which will increase wholesars' inventories, which will decrease wholesalers' orders from manufacturers. (This process may well be sped up, the news of low sales gets upstream fairly quickly.)

At this point, the manufacturers will cut back production. They certainly will not have any reason to purchase new plant and equipment. So, a palpable increase in savings will lead to an increase in investment in inventory until it leads to a decrease in production. There is never a rational connection between an increase in savings and an increase in investment in new plant and equipment.

And, at that point, we step back once more. When there is an increased desire to save, but production -- and, therefore, incomes -- are down, then actual savings may well decrease.

Thus, right-wing efforts to "encourage savings and investment," insofar as they reward savings (in the economic sense) lead not to greater investment in plant and equipment, but to a weaker economy and a less investment in plant and equipment.

But the right-wingers will say, "Palmer, you're only looking at the goods. That's the simple side. We're looking at the money, and that makes all the difference. What happens when savings increase is that more money is available for investment. That will increase investment in plant and equipment." Well, let's look at that claim. Let's assume -- which is to their advantage and is nearly true -- that all the saved money goes into the financial system. That's $60,000,000 more money available for investment. But, remember, that there was -- at the beginning -- $60,000,000 more inventory. That absorbs the extra money in the financial system.

Later, of course, the retailers draw down their inventory. The inventory bulge is on the wholesalers' shelves -- and at a lesser price. Later still, the inventory is on the manufactureres' shelves at a still-lower price. But, throughout the process, the total increase in savings is represented by the increase in inventory. Only when the manufacturers have cut back production does the inventory bulge disappear, and -- by then -- the savings are disappearing just as rapidly. At no time is there extra money for investment in plant and equipment.

------------------

The actual proposals for "Increasing savings and investment" often have quite complicated effects. Take, for example, lowering the marginal tax rates on dividends. This:

  1. Does increase the reward for buying stocks and consuming in the future over consuming now.
  1. Changes a significant part of the income of the class that buy treasury bonds and stocks from payment of taxes to purchase of treasury bonds. (Any decrease in tax collection has to be matched by an increse in federal borrowing.)
  1. Gives an incentive to buy stocks rather than bonds and other securities.

Leaving aside (3), which is an interference in the market which the right-wing only approves when it comes from a tax cut, let's consider how the other two interact.

Well, when your after-tax income increases, you're expected to consume more. Since (2) increases the income of that class, it would be expected to increase their consumption. OTOH, (1) should decrease their consumption -- which means increasing their savings. There is no theoretical reason to suggest that one effect overwhelms the other. Newspaper reports of particular activities of particular merchant princes suggest that the consumption increases. That means that the savings increase less than the income does. Since the treasury must sell bonds to cover the loss in taxation, the increase in savings goes only to the purchase of treasury bonds; the purchase of other securities is less than it would have been under less favorable-to-the-rich taxation.

Originally posted to Frank Palmer on Tue Jul 27, 2010 at 10:37 AM PDT.

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Comment Preferences

  •  Tip Jar (12+ / 0-)

    Corporations are people; money is speech.
    1984 - George Orwell

    by Frank Palmer on Tue Jul 27, 2010 at 10:37:27 AM PDT

  •  Good Diary. (2+ / 0-)
    Recommended by:
    pico, trashablanca

    One puzzling aspect about the economy is the "Paradox of Thrift".  While everyone wants people to save more, the immediate effect is that the economy starts to contract.  
    You're almost in a no-win situation.  The economy is tapped out so people can't keep spending like they have.
    Yet if people start saving, the economy gets worse!!!!
    This is exactly what we saw recently at the G-20 meeting.  The European countries are planning to cut back, drastically.
    The US doesn't want that because it will harm our """recovery""".  Obama even appealed to the countries with dough to keep up their deficit spending.

    The obvious solution is to GO AHEAD and save.  Even if it hurts, we in this country need to increase our savings.  It's currently at ? what minus 5%?  It's atrocious.
    We will build wealth gradually.  

    •  Meanwhile (0+ / 0-)
      Meanwhile, our friends and neighbors are out of work.

      But that is less important than piling up certificates of something in our bank accounts. When we have enough of them we will be able to
      WHAT?

      Corporations are people; money is speech.
      1984 - George Orwell

      by Frank Palmer on Wed Jul 28, 2010 at 09:22:21 AM PDT

      [ Parent ]

  •  Clear description of savings and investment (2+ / 0-)
    Recommended by:
    Liberal Thinking, pico

    and the paradox of savings; however, in the "post-industrial" economy, where "savings" are allocated to non-industrial "investment" eg gambling in synthetic financial instruments instead of land, labor or capital goods, the traditional plant and equipment for production, the economic arithmetic of a closed system, in effect, seems to be failing.

    The traditional "incentives" based on industrial production and distribution models doesn't seem to describe what's actually going on in the social/economic construct of the economy. I believe the disconnect in "investment" is the source of the problem and the assumption that "savings" will necessarily result in beneficial effect, as you clearly state in your diary.

    Although economics is at some level a "mathematical" paradigm it is also a method of analysis of informational, psychological, political and social factors. Many of these inputs do not lend themselves easily to quantification and distort purely mathematical economic modeling.

    I do not take issue with your analysis as far as it goes; however, the assumption of net balance in a closed system is clearly an economic construct that cannot be applied to nation states anymore.

    Factoring in assumptions of the net effect of the actions of policies and investment/cash/trade flows on a global scale is inherently difficult to model and leave the economist with significant information gaps. I strongly believe that we need a new paradigm and less reliance on traditional theory, which seem to have broken down in any case...

     

    "Intelligence is quickness in seeing things as they are..." George Santayana

    by KJG52 on Tue Jul 27, 2010 at 01:03:16 PM PDT

    •  Following the cape (0+ / 0-)

      A bullfighter gets the bull to follow hte cape.
      A magician gets you to look at his sexy assistant so you don't see what his hands are doing.
      When we try to follow the paper, money, rather than the goods wew are doing the same thing to ourselves.

      What you have to follow is the products. When we save, we are not buying products -- generally, in hopes of buying some later products.

      What people do with money is often sick, but it ain;'t the problem with the economy.

      Corporations are people; money is speech.
      1984 - George Orwell

      by Frank Palmer on Wed Jul 28, 2010 at 09:26:30 AM PDT

      [ Parent ]

  •  Good Information on a Little-Known Area (0+ / 0-)

    This article has a lot of good information and analysis of a little-known area of economics. The intuitive consequences of "saving" on the economy are not necessarily what you actually get.

    I would suggest that you edit this diary to clean up the typos, however. Do you put your diaries into Word or some other word processor that will spell check them first? If not, that's a good way to avoid some of these problems.

    As to the relationship of savings to investment (in means of production), I don't think this is obvious. For one thing, it does really depend on where the money is saved. Most money that workers earn goes into their checking accounts and is spent during the month. If they slow down their spending (save) then that means that relatively more money remains in those checking accounts.

    But, as you probably know, these accounts are lent out multiple times (in an economic sense). How many times depends on the Fed deposit requirements. So, if a person saves a hundred dollars in any given month over what they would have spent, then demand deposits (across all the banks) grow at some multiplier of that. You might have an additional $700 in them, for example (if the multiplier is 7). This creates a lot more money available for loans.

    Since the interest rates on business loans are related to how much money is available to loan, when the amount goes up the interest rates go down. While the economy might not be producing more demand for business borrowing (and home loans, too, of course), the lower rate will make certain kinds of borrowing more feasible for businesses. Depending on their assessment of the long-term risk of expanding, businesses may well take advantage of this lower rate to expand. This can be especially true if they think that business will rebound in, say, a year or so, and they want to borrow to build a factory or other facility, which may take a year or more to plan and build.

    So, while you're correct that the choice to save rather than spend depresses economic demand for products, at the same time it can effect the interest rates to the point where investing can be a smart move for businesses.

    I really think our problem in the U.S. is more to do with the types of jobs we've retained after unrestricted globalization. Because we have allowed companies to make products anywhere and sell them in the U.S., we have opened our wage market to foreign competition. Since nearly all the world has lower wages than the U.S. this means that workers must compete against people offering to work for far less money. This has allowed multinational companies to make profits off what I call "wage arbitrage", where they make products where the wages are low and sell them where the wages are high. This can only take place for so long, because products can only be bought if the buyer has money, and they can only get that from an ongoing job (earnings) or by selling off assets, or by borrowing. We’ve sold off enormous quantities of assets to maintain our standard of living and taken on debt, as well. In the long term, we have to be able to earn the money to buy or we will no longer be able to support our standard of living.

    Wage arbitrage particularly affects manufacturing jobs, as long as the product can be reasonably shipped. But, because we have such relatively low costs for oil, and most goods are shipped by boat, the cost of manufacturing plus shipping from another country (let's call it "China") is always less than the cost of manufacturing here (with minor shipping costs).

    But manufacturing jobs are much more heavily wealth-creating jobs than most other jobs. A wealth-creating job is one in which the utility of the product is greater than the utility of the resources consumed in making it. For comparison, many jobs are wealth-distributing jobs. A wealth-distributing job takes a product already created and moves it around or re-factors ownership of it. It doesn't increase the utility of the product. (Other typically wealth-creating jobs are agricultural jobs and mining jobs, but any job that produces a product of more utility than the resources consumed qualifies, even if we call it a "service" job.)

    The U.S. has lost about 25% of its manufacturing jobs since they peaked in the 1970s. This, despite population growth. So, we have been shipping wealth-creating jobs overseas and retaining wealth-distributing jobs.

    In order to have a healthy economy, we need a good balance of the two types of jobs. If you have too many wealth-creating jobs relative to wealth-distributing ones, then you have a stupid economy that is wasteful of effort. If you have the opposite mix, then you impoverish the economy because you don't create the necessary wealth to distribute. (This is the current case for the U.S.)

    As KJG52 says, we need a new paradigm. We need to concentrate a little on how wealth is created and make sure that the U.S. has enough wealth creation going on to retain a viable economy. To do that, we need to spend more time working on how to move wealth-creating jobs back to the U.S. and less on the saving rate (which would take care of itself in a healthy economy). We also need to move beyond "stimulus" as an answer and move to "more wealth-creating jobs" as an answer. My suggestion has been an international minimum wage that will send a strong message to corporations that they need to build capacity in this country in order to serve our markets.

    Thanks for contributing a very interesting diary to the mix.

    •  The typos are a mite distracting, (2+ / 0-)

      however I like the word bovernment, implying rule by cows, which is apropos.
      Otherwise, it's a very informative diary and explains why some of the ruling class are investing in food commodities, since people can increase their savings by not buying widgets, but they still have to eat. Money seems to always follow the easiest path to multiplying itself. If profit can be found by manufacturing widgets elsewhere to be sold here, that's where the money will go. When people can no longer afford widgets of any origin, the money will go elsewhere. It seems to me that large amounts of agricultural commodity investment is the sign of a desperate economy, in that when the economy is healthy, they have lower profit margins than most other investments.

      If nothing is very different from you, what is a little different from you is very different from you. Ursula K. Le Guin

      by northsylvania on Wed Jul 28, 2010 at 01:42:46 AM PDT

      [ Parent ]

      •  The workers are most exploitable aka profitable (0+ / 0-)

        Food production, from fields to chicken coups to slaughterhouses employs some of unskilled, undocumented, poorest and therefore vulnerable workers. An ideal investments opportunity since employers don't need to worry about employee organization or mobility.

      •  Bloverment, More Likely (0+ / 0-)

        Ha! Rule by cows. Yes, that is descriptive and certainly apropos.

        But, I kind of think maybe "bloverment" would be better, because the salient point may be that we have so many members of government that turn out to be bloviators.

        Cheers!

    •  Two points. (1+ / 0-)
      Recommended by:
      Liberal Thinking
      1. Typos.

      I write in a simple word processor without spell-checker, but also without all the hidden stuff which shows up when you post it. Then  I spell check with Wrod Pervert. Every once in a while, when I try to open the file in Word Pervert, it says that it would rather open some other process. I have found a work-around. (Your work-around is not to buy Word Perfect.) Unfortunately, I found the work-around after uploading this.

      1. "Where the money is saved":

      You'll notice I didn't say anything about the money, except for "claims on production." Following the paper is almost always a blunder. What is produced goes somewhere. What is produced but not consumed, that is savings (if we ignore government for a second), goes into investment in plant, equipment, and inventory. Where you put the money is a distraction.

      Corporations are people; money is speech.
      1984 - George Orwell

      by Frank Palmer on Wed Jul 28, 2010 at 09:36:09 AM PDT

      [ Parent ]

      •  Ooops! (0+ / 0-)

        Somehow this got put under Northsylvania's comment.

        I meant it for Liberal Thinking's comment.

        Corporations are people; money is speech.
        1984 - George Orwell

        by Frank Palmer on Wed Jul 28, 2010 at 09:37:59 AM PDT

        [ Parent ]

        •  No Problem (0+ / 0-)

          I still found it.

          My sole point about investment is that the interest rate does matter as to when it is feasible for businesses to invest, and business makes some investment not given current production needs but rather depending on what those businesses think future needs will be.

          I'm still fuzzy on what you mean by a "claim", as in "claims on production". Perhaps you could elaborate.

          As for the word processor, I suspect you can find other options. I've never been a fan of MS Word. I have not found that any hidden things pop up when I post, but that's probably because I use cut and paste to transfer the text from Word to the browser fields on the diary entry form. (This means, of course, that I have to type in the hypertext tags to get things like italics and block quotes, so that they come out right in the final result. I also have to be careful to straighten the quotes and apostrophes in the poll, which you can do in Word by typing control-Z right after you enter them, or the codes will turn to nonsense when they are copied. They seem to work okay in the main body of the diary.) Getting these things correct is beaucoup annoying, isn't it?

          If you find a typo after publishing, I'd encourage you to edit the post. Lots of us get to it much, much later. :-)

          •  points. (1+ / 0-)
            Recommended by:
            Liberal Thinking

            My sole point about investment is that the interest rate does matter as to when it is feasible for businesses to invest, and business makes some investment not given current production needs but rather depending on what those businesses think future needs will be.

            But, when people save -- that is, when they don't consume -- that increases inventory. One can follow the money and imagine that the extra money in bank accounts will mean that more money is available for paying investment in plant and equipment. Actually, it is already paying for investment in inventory. hence, there is no reason for not consuming to lower interest rates.

            Sure, businesses invest according to what they expect business to be like in the future. What you have to explain, however, is why a decrease in present levels of business will lead any sane businessman to increase his expectations of what business will be like in the future.

            Claims on production.

            Is just what money is. People attach a magic sense to money. They think it goes around all by itself. Well it doesn't.
            Actually, while money will get an individual almost any amount of wealth, money doesn't do anything for society except faexchange of goods and seervices.

            Corporations are people; money is speech.
            1984 - George Orwell

            by Frank Palmer on Fri Jul 30, 2010 at 08:56:28 AM PDT

            [ Parent ]

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