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January 20, 2008

Without Savings There Can Be No Economic Growth
by Gerard Jackson

Gerard Jackson BrookesNews.Com Monday 21 January 2008

To say that the economics profession is schizophrenic about economic growth and savings would be a mild understatement. The economic commentariat tell us that consumption drives the economy and that consumer spending must be maintained if the economy is to avoid recession. They then tell us that we need to save more if we are to raise living standards. It completely eludes them that they stating a contradiction in terms.

Kenneth Davidson of The Age is a particularly ludicrous example of the kind of thing I am referring to. In order strengthen his vulgar Keynesianism he once referred to the so-called findings of a 1993 World Bank study called The East Asian Miracle: Economic Growth and Public Policy which claimed that though income and savings were highly correlated, income rises often preceded rises in savings. From this the authors drew the absurd conclusion that growth might drive saving rather than the reverse.

Missing from Davidson's brilliant views on savings and growth were their definitions. Savings are usually defined as an act of not consuming. This is only partly correct. The full definition is that savings is a process by which present goods are transformed into future goods, i.e., capital goods, that produce a greater flow of consumer goods at some further point in time. In short, present goods in the form of money are used to direct resources from consumption (the production of consumer goods) into the production of capital goods. From this we (with the evident exception of Davidson) can deduce that growth is the accumulation of capital goods.

Nevertheless, even this somewhat more realistic definition is misleading because it can convey the impression that growth is nothing more than the simple accumulation of capital goods. This is the kind of theoretical trap that greens and neoclassical economists fall into, even though in practise the latter recognise the heterogeneous nature of capital goods. Capital, as Austrian school economists point out, is a heterogeneous structure consisting of complex stages of production. As more and more stages of production (roundabout methods) are added to the structure it becomes even more complex and productive.

Now what is being suggested is that this structure can grow faster than savings. But how can that be when it equals savings? Put another way: it is being stated that growth can occur without any sacrifice of consumption. In case you did not know, this is called magic pudding economics.

It is ridiculous that it still has to be stressed that you cannot add to the capital structure without sacrificing consumption. (To argue otherwise would be to claim that we can, for example, grow wheat without planting seed corn). Conversely, to dissave means withdrawing resources from the structure thus reducing its productivity. Wicksell explained that when savings take place

[n]o drag on prices need then arise. The commodities of which the saver forgoes the consumption will not, in a properly ordered system, be produced at all, since the units of labour and natural resources which would have been employed in their production will now be employed in preparations for future production. Apart from some inevitable economic friction everything else will remain unchanged at the moment of saving, but production will have become more capitalistic, i.e. directed more towards the future, and consequently, as a rule, more fruitful. (Knut Wicksell Lectures on Political Economy, Vol. II: Money, George Routledge & Sons LTD., 1935, pp. 11-12).

We can therefore conclude that saving really is a virtue and that those who save indirectly raise the living standards of their fellow citizens. Hahn (a reformed proto-Keynesian) pointed out that the saver

... improves his own welfare because saving implies the transfer of means for consumption from the present, where his earnings are ample, into the future where his earnings may become scarce through old age and sickness. Furthermore, saving will increase his means through the interest he receives. (Albert Hahn, The Economics of Illusion, Squier Publishing Co., Inc, 1949, p. 94).

However, by using credit expansion the impression can be given that an economy has grown faster than it has saved. By this process businesses can direct resources away from consumption to investment, giving the impression that investment now exceeds savings. This is called inflation. It should be noted that the apparent discrepancy between investment and savings is really a monetary illusion, the product of a monetary disturbance. In real terms investment still, as it must always do, equals savings, even if they are forced savings.

Davidson has made the absurd class-war accusation that Treasury 'ideology' held back savings by restraining growth because it put the "interests of rentiers (people who save) ahead of real entrepreneurs" who make real investments that create jobs. What he means by this Keynesian ideological claptrap is that the Treasury should be forced to lower interest rates to stimulate investment. But this is the very policy that gave us the 1980s boom followed by "the depression we had to have". In other words, what Davidson called for was more inflation followed by another recession. (This is precisely what the Howard Government gave us. The irony here is that it will be a Labor Government that will suffer the political consequences of the Howard boom).

Of course, Davidson defended his absurdities by asserting that the 1930s depression was caused by neoclassical economic policies that also led to World War II. This is complete and utter drivel. Moreover, it should be noted that he ignored the role that tariffs played in wrecking international trade, deepening the depression and aggravating international relations. Did he do this because he supports tariffs?

That the Great Depression was caused by free-market economic policies is a myth. Unfortunately, it is a myth that Australia's so-called rightwing refuses to question.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2009 Gerard Jackson

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