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.

The sentiment of a large majority of the active business community

Reading classical economics for me is to be in the company of economists who understood how economies worked. I have of late been reading Simon Newcomb’s “The Problem of Economic Education” which was published in The Quarterly Journal of Economics in July 1893. And what he does is go through the kinds of economic illiteracy that was all too common in the general population of his time, with a decidedly pessimistic view of whether these ideas can ever be eradicated amongst the population in general. And this was even though there was then universal understanding amongst economists about how fallacious these fallacious ideas were. An example:

From the economic point of view, the value of an industry is measured by the utility and cheapness of its products. From the popular point of view, utility is nearly lost sight of. . . . The benefit is supposed to be measured by the number of laborers and the sum total of wages which can be gained by pursuing the industry. . . . Here legislation only reflects the sentiment of a large majority of the active business community. A man’s economic usefulness to society is supposed to be measured by his expenditure of money and consumption of goods. He who spends freely is pointed out as a benefactor; while the miser, who invests his income, is looked upon as a selfish being, mindful only of his own aggrandizement. (p. 7)

Well, that was in 1893 for goodness sake. Who today would think spending is good and saving bad? From The Australian today:

CLIVE Palmer wants the age at which Australians can access their superannuation lowered, saying it will boost domestic demand for goods and services and increase economic growth. . . .

“I think we should be allowing people to access their super at 50 if they want to.

“It’s up to them, it’s their savings … we want to get that money released from the super funds.”

On this, Newcomb wasn’t even close to being pessimistic enough. Now, and since 1936, even economists think saving is a bad thing and spending is good.

A skill testing question in economics from 1886

The mail has just brought me my own copy of Simon Newcomb’s great 1886 economics text, Principles of Political Economy. Just for fun, I offer you one of the questions at the end of one of the chapters that no modern student of economics ever gets asked or would likely have a ready answer to.

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

Even the notion of a frugal population is pretty antique. But all the difference in the world lies in the answer to that question.