Killing the saving goose that lays the golden consumption egg

Governments have, throughout history, attempted to suspend the laws of economics.  Through various measures such as using price controls, subsidies, or regulations, governments attempt to achieve their own predetermined ends.  Ultimately, these interventions have unintended consequences that require additional interventions at a later stage to correct the failures of the initial intervention.  Other internvetions, such as depleting real savings through monetary policy, ultimately have as their only solution a complete cutback of consumption.

Today, we are told by our economic gurus that spending equals economic growth.  Saving is something which is a paradox – a growth killer when it happens.  Opening the hood of human and economic action and revealing the function that saving and investment serves in a growing economy easily dispels this fallacy.

We use the example of the Robinson Crusoe economy to explain the economic concept.  The Crusoe economy consists of one man stranded on an island in the pacific, where no capital goods exist and where only natural factors of production including his labour exists.

Crusoe lives off the raw earth, eating mainly fish, and sleeps under the stars.  He has no fishing rod or any other capital goods at his disposal.  Every single day, Crusoe spends 10 hours fishing, catching on average five fish a day.  This is just enough to feed himself (these are little fish after all and there are no snoek in the Pacific, not to mention in the shallow waters).

Crusoe labours long and hard every day, and his disutility of labour weighs on him.  Crusoe feels he’d like to improve his standard of living by having more time for leisure, so he can relax on the beach and make something similar to roll-mops with his catch of the day.

His solution is to make a contraption made from wood called a spear, which will enable him to catch five fish in a seven hour time frame – a near doubling in his productivity.

It will take Crusoe 40 hours to make this spear.  He must go into the woods to find the right stick, he must sharpen it and remove the bark before it is ready to do the job.

In order to spend time making the spear, he doesn’t have any choice but to cut back on consumption before his standard of living can improve.  Either he must reduce hours spent fishing, or he must reduce his leisure time in the evenings to make time for capital formation, the creation of the spear.

With option one, there will be less fish caught, meaning less fish to consume in the evening.  With option two, there will be less time for leisure in the evenings, a consumption good.  A combination of the two options may be used.  Either way, consumption must be reduced to make way for capital formation.

The cutback in consumption is what we call saving.  It’s definition is not only restricted to the number of coins one sticks in a piggy bank, because once one removes the medium of exchange from the equation, this definition is empty.  Saving is an action of deferring consumption to a future date.

So Crusoe decides he will, over the next week, spend three hours a day less fishing and one less hour in the evening relaxing.  In ten days’ time, Crusoe will have had built a spear, his investment.

With his new spear, he can now catch more fish in less time, compared with five previously, which means he can spend less time in the day fishing, and more time on leisure.

This is everywhere and always an axiom of economic action: in order to improve and maintain his standard of living, Crusoe must always save and invest.  Even once Crusoe has made his new spear, he must continue to save and invest if he wants to maintain the spear in a functional condition so that it does not become worn out and blunt.  If he just carries on consuming, without any thought of saving and investing, he will consume his capital (spear), and he will go back to the state that existed before he made the spear.  In other words, his standard of living will be reduced if he doesn’t always consume less than he possibly can.  There must always be saving and investment to maintain a certain standard of living, more so if one wants to improve the standard of living.

Contrast this with what we’re told today about economic growth: that we must spend and consume in order to boost our living standards.  Globally, governments are going as far as to cut interest rates to effectively force people to borrow money that can be spent in order to drive consumption and investment, or GDP, what it calls economic growth.  As if this is not enough, if we won’t borrow to spend, government does it for us by running fiscal deficits. This bill ultimately lands in front of the taxpayer.  In the Crusoe economy there is no debt to speak of, Crusoe only deals with present goods.

Debt is an exchange of a future good for a present good.  To avoid default, one must use debt in the present, to increase ones productive capacity to produce goods in the future so debts can be repaid.  Going into debt to buy consumption goods such as cars, homes, and clothes, is by no means facilitating an increased standard of living.  It must be paid for in the future by taking a drastic reduction in consumption – and the standard of living.

The drastic cutback in consumption WILL take place, it is only a matter of time.  Better start saving for that rainy day.

In fact in remote places of the US it is already happening. The Wall Street Journal ran an article some months ago, telling the story of how some farming communities’ asphalt road network is being torn up and turned into gravel roads (See: Roads to Ruin: Towns Rip Up the Pavement, WSJ, July 17, 2010).