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:
- 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.
- 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.
- "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:
- Does increase the reward for buying stocks and consuming in the future over consuming now.
- 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.)
- 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.