Saving and Investment

I was teaching my usual Keynesian macro as a prelude to explaining the classical theory of the cycle when I came across this. That in the base Keynesian model, if investment is greater than saving (I>S) the economy will grow, and not only that, it will grow until income rises enough to generate the savings needed to fund the investment. I have, of course, taught this many times, but for some reason it was only on this occasion that it really occurred to me just how stupid this is. I have always seen how nonsensical it is to argue recessions are caused by the level of saving being higher than investment but the reverse is, now that I am looking at it, even more absurd. Because if it were even remotely possible for the level of investment to exceed the level of saving, an economy could always lift itself on thin air without having the capital base required to support it.

Let me say it this way. One of my students once posed the following question as part of an assignment: does the person who buys a camera pay the wages of the person who makes the camera? And to make it clear what his point really was, his question can be put this way: does the person who buys a camera pay the wages of the person who made the camera since the camera maker will have received his wages months and sometimes even years before the camera was bought by its final purchaser?

Obviously the answer is no. By the time the camera was bought, the workers who had collaborated in its production had been paid their wages long before. So how did the camera maker get paid? He was paid out of the collective savings of the nation that allowed this employee to receive his wage before the camera producer had found a buyer for the product itself. The availability of saving is the only means by which incomes can be earned before the products being produced are sold to their final buyers. No matter how you twist the theoretical structures one way or the other, an economy cannot buy more than it has produced, and if those who are producing are going to be paid a real wage with genuine purchasing power, the products they receive when they spend their money must come out of the collective savings of the nation. (OK the savings could come from overseas, but that’s not a solution to the problem; it only enlarges it.)

The deficits and debts we see around us everywhere are a consequence of a Keynesian model which has been fashioned on the belief that there is some means to conjure goods and services into existence merely by spending money to buy them. It is such a hopelessly false idea, but since something like 95% of the world’s economists believe this stuff, or at least have never stopped to think about it, on they go, advising governments to take actions to create demand for 105% of everything available for sale.

And because governments get first dibs at what’s available since they get to print the money they are buying things with, they don’t notice that there are no savings to back up the demands they make. It is the private sector that finds itself unable to grow and employ since the inputs they would normally have put to use have been already taken up by governments. But since economic theory tells governments this is the right thing to do even when common sense should tell them that it’s not, on they go, creating a wreck of any economy where this Keynesian stuff is being tried.

I’m afraid there is no helping it. We are going to have to abandon this demand side Keynesian view of things and return to the classics.

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