The economic role of saving

There are two ways to understand the word “saving”. It is either:

(1) deferring the use of one’s purchasing power to a later date


(2) that part of the capital, labour and other existing resources of a community that are used to maintain and extend the productive apparatus of an economy.

If you confuse (1) with (2) you will never understand how an economy works. (1) is of course modern and Keynesian, while (2) is classical and Austrian.

But these things are very very difficult to keep straight in the midst of analysis unless you really have the distinction absolutely clear.

Let me therefore take you to a sad example of how these issues became muddled in the midst of an interview with an Austrian economist who was trying to explain (2) to someone who thinks only in terms of (1). This is the title, Our Obsession with Consumption — while Ignoring Saving and Investment — Is a Big Problem. I have adopted his explanation from his Austrian treatment and translated into how things would be looked at from a classical perspective.

In economics today very little attention is given to the role of savings. This is a very curious situation.

There can be no production without prior saving.

Nature on its own provides us with only very few consumer goods eg apples on a tree.

For anything more, we must first produce the goods that we then afterwards can consume.

But to produce these goods we must first devise and construct tools, instruments or machines.

But to devise and construct tools, instruments or machines we already need a stock of already existing tools, instruments or machines. This stock is what is meant by “saving”.

Without prior savings no increase of future consumption is possible.

But then the interviewer asks this question, which transfers the issue from (2) to (1).

Do the current saving systems for retirement in the West work? If not, with what should they be replaced?

Suddenly the issue is about the future real potential purchasing power that lies behind money saving in the present. And from there the conversation never gets back to the need to widen and deepen our productive capabilities. They do go on to discuss who should make the decisions on what capital to build but by then it is too late.

The real problem for me is that even the interviewer, who was trying to provide soft questions so that the issues could be explained clearly, was too muddled himself and never allowed the interview to go where it needed to go, so another opportunity to make things clear disappeared.

Comic relief at the AFR

I turned from reading Chris Berg and Sinclair’s serious and excellent article on our real tax problem in the Financial Review to its next door neighbour by Brian Toohey dealing with super which must have been provided for comic relief. What is one to make of its opening two sentences?

Australia has a savings glut. So does much of the globe.

One of those mistakes no classical economist would make but every Keynesian does. Could a modern economist even begin to understand why a classical economist might have thought differently? Probably not, which is why we will raise taxes, maintain public spending and lower interest rates and never know what we are doing wrong.

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.