"Saving" ≠ "Saving Resources"*
Many economists — mostly the freshwater/neoclassical/supply-side/conservative types, but also many on the left — hold in their heads a very peculiar model of how economies work. It’s a model of a barter/real-goods economy in which money only plays the role of convenience.
In this model, if you don’t eat some portion of the corn you grew this year, you’ve “saved.” You can eat it next year. Makes perfect sense.
You can see this thinking played out in Scott Sumner’s justification for consumption taxes:
I’d tax people on the basis of how many resources they consume, or take out of society, not what they produce.
He describes the opposite approach — taxing returns on financial investments or “savings” — as “morally grotesque.”
Now let’s think about this, and think about how these economists think about this. They’re assuming that if you “save” (a.k.a. don’t spend), you don’t “consume resources.” You “save” them, and don’t “take them out of society.”
This makes absolutely no sense. If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight — the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains — when you buy it, and only when you buy it, they produce it.
If you don’t buy it, it doesn’t get produced.
And if you don’t buy it, and they don’t expect you to buy it soon, they don’t invest to build the capacity needed to produce more in the future. (That investment and real-capacity building is true “national saving.” S really is I.)
That mental model, which is so widely prevalent, is a fundamental error of composition: confusing the individual with the aggregate. (And a confution of money-saving and real saving.) Sure, you’ve saved money for your (or your great-grandchildren’s) future. And when you don’t get a massage, others can sign up for that time slot, or buy a massage for a lower price. This is about competition among individuals, not how many resources we as a society produce and consume. If we all consume less, as a society we produced (and “save”) less — both for current consumption and for future production.
So in a very real (dynamic) sense, it’s the savers who are “taking resources out of society.” (And in a somewhat abstract sense, you can imagine those foregone resources being stored, hoarded, and rendered impotent in ever-growing and largely inert Cayman-island bank accounts.)
This is not really revelatory; I know these economists understand the paradox of thrift. But they ignore and eschew it in their real-good, barter-based mental economic models. I would suggest that the explanation for this error of composition is revealed by Scott’s words: “morally grotesque.” Moralistic beliefs about how individual humans should behave make it impossible for many economists to embrace an aggregate economic reality of which they are fully cognizant.
* Yes: non-renewable natural resources are consumed when people produce, buy, and consume stuff (both goods and services). But 1. Compared to human effort, those resources constitute a small part of the inputs to GDP, and 2. this is not what economists who are subject to this thinking are talking about. All those in-ground resources are not counted as existing “capital” in the national accounts, for instance — so they can’t be depleted from those accounts — and the accounted “cost” of those resources consists almost entirely of the cost of digging them up. This is the subject for another post.
Cross-posted at Asymptosis.
Steve
I think you are on the right track with this but you give the economists (and economics) too much credit.
All the economists are doing is trying to justify not taxing “income,” because their friends have so much more of it. Taxing “consumption” is cheaper for them because they don’t spend all of their income… or they can spend it in a part of the world where consumption is not taxed.
In any case taxing should probably not be looked at as a moral proposition. It is “just” a way for the state to get the money it needs to do what (the people) want it to do. And the best place to tax is where it is easiest to collect… and, at the risk of contradicting myself, “does no harm.”
that is, taxing the poor is “morally grotesque,” because they have no way to mitigate the tax. Tax the (relatively) rich at the point where they “make” the money and they can to a considerable extent adjust the amount they charge for their services, and, subject to that ol’ time supply and demand, the amount of “money” taken out of the (market) economy adjusts itself equitably. There is a great deal of room on that supply/demand curve for folks who “would have paid more” than the “equilibrium price” under current (pre-tax) conditions.
But you’ll never stop the rich from complaining about taxes.
I’ve tried (and successfully failed) to follow this post, SS’s posts, and some other posts from both sites on the issue of income taxes, savings, and consumption taxes. Any recommendations on where to get a primer on this stuff?
If you really wanted to tax “consumption” of actual physical things, you would have to do it at the mines, wellheads, etc.
Monetary “savings” are merely one form of leverage with which people can mobilize and direct other people to expend energy.
Of course, at one end point of inequality a single agent has all the currency, but at this point the utility of that currency is nil. At the opposite end everyone has equal amounts of currency, and at that instant in time the currency is usable, but probably only for medium sized projects or purposes. Some level of clumpiness is necessary to make large as well as everyday uses possible. Boulders, as well as sand, are necessary to build strongly.
At various points of clumpiness various economies will exist. I think we are approaching, or probably at, a level where there are too many boulders and too little sand. Figuring out an appropriate level of clumpiness could be a valuable economic tool, if anyone paid attention to it.
Of course, I realize there’s every chance the Babylonians or Greeks figured it out 3000 years ago. If so I would be interested to hear. 🙂
That clumpiness can be provided by oligarchs – frex, the nobility who supported Haydn, et al. or by government – frex, the new deal.
It comes down to how much equality you want in your society.
The oligarchs want none.
JzB
I may be biased from my long tenure as an engineer working on products that no one needed before they were produced, but I do think we would have a greater proportion of the population near subsistence if our society had not become so successful at producing.
Nonetheless, I can see that in order to be able to endow a chair at the university you need to both choose the producer track and be successful at it.
well, i think if you are worried about “equality” you are barking up the wrong tree.
worry about “enough” and worry about “opportunity” (real opportunity not theoretical opportunity).
as for noni’s “clumpiness,” not sure i understand it, but perfect equality of “money” would still allow perfectly “normal” commerce.
It’s all about the velocity of money.
Though, I’m for a consumption tax if we are honest about it. Like, taxing those the most who benefit the most from our military and judicial system. I fact, I’ld add a premium on the military consumption tax as it inhibits better directions for social expenditures to build tangeble and intangeble wealth.
This global savings glut and “paradox of thrift” seems to be at the core of our current problems.
I wonder if it’s not related to demographics. Globally there is a huge cohort doing last minute catching up on their retirement savings before they retire within the next fifteen years.
It’s impossible for all of these people to save at the same time without distorting markets, making the interest rates quickly drop and risking a liquidity trap.
I’m not sure what the solution is to this. The only one I can see would be for this cohort to save through real things instead of through investments. They would need to buy non-perishables they will need for the next five year or so. However, it is not clear that this stockpiling can be done efficiently enough. As was mentioned, the fact that we are mostly a service economy is a problem as you can’t hoard services.
Benoit
you don’t have to look too hard to see that the problem is not demographics
it is unregulated banking leading to very rich people who are afraid to lend
and very poor people who are afraid to spend.
1/2
Steve Roth:
“If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight — the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains — when you buy it, and only when you buy it, they produce it.”
You can’t buy a massage unless there were prior acts of saving and investment in massage tables, oils, parlors, etc, and you can’t buy a paint job unless there were prior acts of saving and investment in paint, paint cans, retail/wholesale buildings, transport trucks, etc.
Also, services comprise a large portion of the US economy, but that doesn’t mean that consumer spending is the driver of economic growth. All of those services concern services pertaining to real goods, which have to be produced, which requires saving and investment.
In fact, most of the “spending” that takes place in the US economy over any given year, is overwhelmingly financed by savings, not consumption. This is easily understood if you consider the implications of most spending being consumer spending, and then realize the false conclusion. If most spending was consumer spending, say 70%, then only 30% would be investment spending. With only $0.30 of every dollar spent is invested, and $0.70 out of every dollar is consumed, then profitability in the US economy would average $1.00 revenues minus $0.30 costs divided by $0.30 cost of capital invested equals 233%. But profits are nowhere near that high. Why? Because most spending is actually financed by saving.
“If you don’t buy it, it doesn’t get produced.”
This is incorrect. If the massage tables, oils, parlors don’t get produced, and if the paint, paint cans and retail stores don’t get produced, then you can’t buy those particular massages and you can’t buy that particular paint.
2/2
Steve Roth:
Steve Roth:
“If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight — the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains — when you buy it, and only when you buy it, they produce it.”
You can’t buy a massage unless there were prior acts of saving and investment in massage tables, oils, parlors, etc, and you can’t buy a paint job unless there were prior acts of saving and investment in paint, paint cans, retail/wholesale buildings, transport trucks, etc.
Also, services comprise a large portion of the US economy, but that doesn’t mean that consumer spending is the driver of economic growth. All of those services concern services pertaining to real goods, which have to be produced, which requires saving and investment.
In fact, most of the “spending” that takes place in the US economy over any given year, is overwhelmingly financed by savings, not consumption. This is easily understood if you consider the implications of most spending being consumer spending, and then realize the false conclusion. If most spending was consumer spending, say 70%, then only 30% would be investment spending. With only $0.30 of every dollar spent is invested, and $0.70 out of every dollar is consumed, then profitability in the US economy would average $1.00 revenues minus $0.30 costs divided by $0.30 cost of capital invested equals 233%. But profits are nowhere near that high. Why? Because most spending is actually financed by saving.
“If you don’t buy it, it doesn’t get produced.”
This is incorrect. If the massage tables, oils, parlors don’t get produced, and if the paint, paint cans and retail stores don’t get produced, then you can’t buy those particular massages and you can’t buy that particular paint.
Production comes before consumption. Always and everywhere.
“And if you don’t buy it, and they don’t expect you to buy it soon, they don’t invest to build the capacity needed to produce more in the future. (That investment and real-capacity building is true “national saving.” S really is I.)”
That is incorrect. If you reduce your consumption spending, and you accumulate cash as a result, then the profitability in the capital goods industries will rise relative to the profitability in the consumer goods industries. This will result in relatively less investment in consumers goods than capital goods, which has the net effect of increasing aggregate productivity. With relatively more resources going to capital goods than consumer goods, labor productivity rises.
“That mental model, which is so widely prevalent, is a fundamental error of composition: confusing the individual with the aggregate. (And a confution of money-saving and real saving.) Sure, you’ve saved money for your (or your great-grandchildren’s) future. And when you don’t get a massage, others can sign up for that time slot, or buy a massage for a lower price. This is about competition among individuals, not how many resources we as a society produce and consume. If we all consume less, as a society we produced (and “save”) less — both for current consumption and for future production.”
You’re ignoring the other goods than can be produced by virtue of the change in relative profitability brought about by additional cash holding and reduced consumption spending.
The paradox of thrift is a flawed argument, because lower spending does not necessarily imply lower output. Prices can fall.
@Pete Petepete:
I’m sorry, but you don’t understand “saving.” (You’re not alone.)
If I transfer $100K from my bank to yours for goods or wages, do the banks have more money to lend?
If I instead only transfer $75K, “saving” $25K in my account, do the banks have more money to lend?
Production and trade produce surplus. That surplus is monetized by the financial system (including treasury and fed). That’s why the quantity of financial assets (“money”) keeps increasing.
If producers can’t sell (trade) their goods, they don’t produce them (as a successful serial entrepreneur, I’m here to tell you…), and you get less surplus. Spending causes saving.
> lower spending does not necessarily imply lower output. Prices can fall.
But I’m sure you’ve noticed that the Fed doesn’t allow that (or only rarely). You’re ignoring the active role of the financial system in the real economy.
1/2
Steve Roth:
Thanks, but you really don’t have to apologize for being wrong. You’re definitely not alone among those who conflate cash holding and saving. Goodness knows there are a lot of people who believe the same error as you. It’s why there is such a debate over it!
“If I transfer $100K from my bank to yours for goods or wages, do the banks have more money to lend?”
“If I instead only transfer $75K, “saving” $25K in my account, do the banks have more money to lend?”
You are again ignoring the effects that these two different activities have on the relative profitability between industrial sectors in the economy, which then affects the aggregate productivity of the economy.
You ought to compare the effects on things other than bank’s ability to lend. Lending isn’t the only source of capital, and the extent of lending isn’t the only determinant on economic productivity.
If you consume $75k instead of $100k, then what is the difference to relative profitability between consumer goods and capital goods?
Well, consuming $75k and holding $25k as cash, out of every $100k earned, would generate a higher relative profitability in the capital goods sector, as compared to consuming $100k and holding $0 out of every $100k earned.
Thus, your holding $25k as cash would make capital goods relatively more profitable than consumer goods. Investors would then be allocating relatively more capital to capital goods than consumer goods. The effect of this would be an EXPANSION of aggregate industry.
You’re still making the mistake of believing that consumption spending drives the economy forward. But if everyone only spent money on consumption, then the economy would not grow at all.
Thankfully, because there are investors who save and invest, their activity and the resulting productivity in the economy are guided by the cash holding preferences of individuals!
What has happened in your example is that what economists call time preference is lower with $75k consumption, than it is with $100k consumption. Your time preference is lower because the ratio of your consumption to your investment is lower. You are consuming less with $75k than you are with $100k. And that is communicated to investors via the lower relative profitability of consumer goods to capital goods that you brought about, which made the economy more capital intensive!
2/2
Steve Roth:
“Production and trade produce surplus. That surplus is monetized by the financial system (including treasury and fed). That’s why the quantity of financial assets (“money”) keeps increasing.”
First, you’re not focusing on the correct processes. Second, you’re just describing inflation that benefits special interest groups. It is not necessary for inflation to occur.
“If producers can’t sell (trade) their goods, they don’t produce them (as a successful serial entrepreneur, I’m here to tell you…), and you get less surplus. Spending causes saving.”
Producers don’t only sell consumer goods. I am here to tell you, as a former successful seller of capital goods, that my revenues were derived 100% from savings, because the money I earned was not for selling consumer goods. If society’s savings were lower, then it is more likely my income would have been lower. But without my production of capital goods, all the consumer goods sellers that depended on my capital, would have to make do with less capital, which means they would have produced fewer consumer goods, just as the fall in savings was the result of a rise in consumer spending! Yes, consumer spending would have been higher even as the quantity of consumer goods sold is lower.
Unless you produce money yourself, you can’t spend what you have not already earned. If you are a wage earner, then your spending is contingent upon others abstaining from their own consumption (saving) and making available to you the money of which you take ownership. If you are a capital goods seller, same thing. Only consumer goods sellers depend on consumer spending, and even there, they physically depend on capital goods sellers for their materials and equipment needed to make consumer goods.
>But I’m sure you’ve noticed that the Fed doesn’t allow that (or only rarely). You’re ignoring the active role of the financial system in the real economy.
I was just following your assumption of falling aggregate spending. If you now consider the Fed reversing the fall in prices, then that would lead to a rise in aggregate spending, given supply doesn’t fall. So you’re saying two mutually incompatible things here.
This comment has been removed by the author.
Pete petepete,
As I read your postings, it seems you are moving the discussion toward the chicken or the egg type.
“As I read your postings, it seems you are moving the discussion toward the chicken or the egg type.”
Not at all Daniel. I hold that the egg came before the chicken, as do most biologists.
For saving, investment, production, and consumption, and other such categories, I hold that production always comes before consumption, and that saving is always and everywhere exactly equal to investment (I do not define cash holding as saving, hence the difference between my and Roth’s arguments).
Steve’s examples are thin, and testament to the weakness of reversing economic causality. He is compelled to exaggerate “just in time” production because that is the closest his beliefs come to reality (it doesn’t actually get there however).
Even if Roth can identify a producer that assembles a final good only after receiving an order of payment from a consumer, that still doesn’t imply consumption precedes production. In these cases, the relevant saving and investment are the materials that have to have already been produced and made available in order for the seller to assemble the final good. Here, saving and investment still precedes consumption.
Your post is rather ironic, because it is usually my “consumptionist” interlocutors who usually respond to my argument above by deferring to chicken and egg type arguments. That because producers rely on consumer spending, and because consumers rely on producers, that it is a chicken and egg scenario in real life, so it doesn’t matter which view you hold, it’s no worse or better than the other view.
Except that is not my position at all. I am against the chicken and egg defense/apologia for not strictly adhering to the one directional “production then consumption.”
In the Sumner piece, taxes and inequality are discussed. It seems he feels his proposal makes things more equal somehow.
Here is where I take issue.
If we are measuring equality in dollar terms, simply raising taxes on something does not automatically, based on some special forces of taxes, get redistributed to lower income groups.
The recent tax hikes simply reduce the amount of debt issued. Congress is not helicopter dropping that money to lower income groups. Sure some people’s after tax income is a smidge closer to lower rungs, but those lower rungs do not get that money as congress has not implemented much of anything except maybe Obamacare.
Next point how do we know that higher taxes don’t increase inequality? Maybe that causes people to rent seek more, or bargain for austerity. Europe has higher taxes, and they have an economic mess with high unemployment.
So if we measure equality in dollars, and the government is the monopoly supplier of dollars, than inequality can only be effected by targeting dollars to the lower rungs, which can happen independent of any changes to income taxes or adding a consumption tax. If Europe want to lower unemployment then Euros need to be issued. If we want lower inequity then new/higher dollar programs need to be targeted to the lower groups.