Saving and investment as understood in 1886

This is from a note I have just written discussing the 2nd ed of my Free Market Economics. What is most interesting perhaps is the question that was found at the back of a chapter in an economics text published in 1886. Note the assumption that higher saving leads to higher growth, and more mysteriously, that money placed in a bank is not what savings really consist of. All very routine in 1886, now near incomprehensible.

The book being so far from the standard, even people who are potentially sympathetic to what it is trying to explain will be puzzled because of the way in which economic theory is currently taught. I have had the experience now for the past ten semesters in seeing students who don’t get it at the start, specially if they have done economics before, suddenly catching on. What now establishes the course material is that everyone is perfectly aware that neither the stimulus nor the low interest rate regime have brought recovery with it but cannot understand why. So I point out that if you were a classical economist, the economics you would have been taught would have explained all that already, and then I explain what every good classical economist would have known. The question below is one of my favourite questions for this part of the course.

What did Simon Newcomb mean when he asked this question in his 1886 Principles of Political Economy text:

“Trace the economic effect of the frugal New England population putting their money into savings banks. What do such savings really consist of?”

a) for a community the amount of money in banks is not what is meant by saving
b) the economic effect is that a larger proportion of its resources are made available for investment
c) high saving would mean high unemployment
d) money facilitates exchange but resources are what matters
e) the New England economy would be expected to grow only very slowly

It’s useful to me since I try to emphasise that I didn’t make this up but that there is a long pedigree to what I teach. It’s only that since 1936 there has been such a discontinuity in economics that the kind of question found at the end of an introductory text in 1886 would be virtually unanswerable using modern theory. “What do such savings really consist of?” is near on incomprehensible to anyone who has only learned modern macro.

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