Why Saving for a Rainy Day is Pointless — For the Economy
By James Livingston
By examining history, economic historian James “Against Thrift” Livingston says the sacrifice of saving for a rainy day — of foregoing present consumption on behalf of future growth — could be potentially destructive of the general welfare. And he says that John Maynard Keynes would be on his side. Photo by Deborah Harrison/Getty Images.
A Note from Paul Solman: Thursday’s post on The Business Desk featured the latest libertarian salvo from John Papola, whose brilliant economics videos, “Keynes vs. Hayek: Late Economists’ Hip-Hop Legacy” and “‘Tis the Season, But Should We Save or Spend? A Holiday Money Conundrum”,” we have highlighted — some might say, exploited — on PBS NewsHour.
In retort, we feature a response from liberal economic historian James Livingston, whom I first encountered when I read “Against Thrift,” his feisty book-length argument in favor of consumption.
It would be better to read Papola and then Livingston’s reply on “the nonsense of austerity” to get the basics of the debate. Both posts ran on March 6 and elicited more than 500 comments between them.
James Livingston: John Papola’s riposte surprises me: he has made me rethink certain assumptions that were hitherto privileged, you might even say sheltered, by long years of thinking across the grain of mainstream economic theory. So to begin with, thanks, John. I needed that.
Let me first outline the broad areas of agreement that unite us, and then turn to the significant differences that still divide us — the differences that might be bridged by attention to historical evidence as against theoretical postulates; the difference that results in my urging us all to spend instead of worrying so much about saving in order to invest.
John begins by suggesting that the bedlam of contemporary economic theory forces us back to 18th and 19th century foundations or precedents. He’s right. The difference between us is that I reach for the likes of Karl Marx, Paul Leroy-Beaulieu, and Charles Conant, while he pulls David Hume, Adam Smith, and John Stuart Mill off the shelf. How to adjudicate this choice?
The question has to be answered by reference to the explanatory adequacy of these famous and not-so-famous long-dead “economists.” Do these theorists of the past let us address the actually existing conditions of today’s post-industrial capitalism, in crisis or not? Beyond that, do they permit a practical, programmatic approach to such conditions? In my view, John Maynard Keynes is the rightful heir to the intellectual legacy of Marx, Beaulieu, and Conant, not his English predecessors. And it is Keynes’ notions of saving, investment, growth, and business cycles that I endorse.
But then John Papola makes the identical claim. He goes to great lengths in his riposte to claim that the Keynesian model is more consistent with his savings-and-investment argument than mine — and he may be right. The ambiguities multiply: if we’re both citing Keynes, what’s going on here?
John also suggests, in line with Thomas Kuhn’s disturbing ideas about scientific revolutions, that facts — “the data” — are functions of models, not the other way around. I am in complete agreement. But I want us to consult, compare, and conclude with the historical evidence, even as I acknowledge that such evidence is a result of model building, not the archive we discover without theoretical preconceptions.
How then to choose between facts to fit the models?
If the model determines the range of facts we can take for granted, how do we decide between rival accounts of the very same factual phenomenon (in this case, economic crisis)? How do we decide without resorting to the language of values and purposes–the language of moral philosophy: my model is more virtuous than yours?
Clearly, we can’t: whatever the model, it presupposes the values and purposes of the person who deploys it. And to his credit, John doesn’t dodge the question. He believes, and says, that the consumption of goods is not merely enabled but must be authorized by the prior production of goods. There can be no consumption without production, therefore we must always emphasize the latter. But in saying this, he turns the ideal of equilibrium and the prospect of growth into moral imperatives.
With this line of reasoning, though, John also locks himself into an impossible moral dilemma. The problem is that a market society emphasizing production relies on costs and profits, which in turn rely on the assumption that a producer’s income is commensurable with effort. As if.
As if hard work on Main Street were rewarded proportionately to paperwork on Wall Street. As if the outlandish salaries and stock options of contemporary CEOs are justifiable in terms of “adding value.” As if just having a job will take you off food stamps (about 25 percent of American workers don’t earn enough to raise themselves above the poverty line). Or — as if you’re unemployed because you’re lazy.
Is the market system fair and efficient? Is it a necessary evil? Or is it a system all too vulnerable to hijacking by the powerful in the name of savings, investment and ever-greater production?
Still, by enlisting Keynes in his account of how saving and investment must drive growth, John Papola has revealed — or merely reiterated — a fundamental truth, which is that the mainstream of economic theory from left to right, from Dean Baker and Paul Krugman to Gregory Mankiw and Martin Feldstein, clings to the assumption that, as John puts it, “real growth comes from value-adding investment and production.” For example, Dean Baker, the epitome of left-Keynesian rectitude, criticized my New York Times op-ed of Oct. 28, 2011 by saying pretty much what John does: of course investment is the source of productivity and growth, and that anyone who says otherwise must be uncouth or, what is the same thing, untrained in economic theory.
In this sense, they — Dean Baker and John Papola — represent the broad mainstream of more or less Keynesian economic theory. I’m still outside it, but that’s not a complaint. It’s a way of saying that the consensus on saving and investment as the causes of growth is well-nigh universal, and that the would-be renegades, like Baker and Papola, haven’t left the reservation, regardless of what they profess.
But here’s the thing: Baker and Papola are both right and wrong about Keynes, about investment, and about growth.
Yes, Keynes assumed that investment would eventually drive growth. But (like Hayek) he did not assume that investment flowed naturally from savings at any given interest rate, no matter how it affected consumption. And so Keynes refused to assume that consumer spending was a simple function of either idle savings or active investment. He knew that savings and investment never translated automatically into job creation and thus money in the hands of employees.
Like Papola, who says in passing that growth “is created by value-adding production and investment either from the private sector or the public sector,” Keynes didn’t care about the sources of investment. He cared solely about their consequences for consumption.
Keynes was not always consistent. He divulged his divided state of mind in three rhetorical modes that didn’t often intersect. There is the erudite aplomb of “The General Theory” from 1936, his classic effort to entreat countries like the United Kingdom and the United States to spend and spend to counteract the Great Depression.
The book’s punch line is this:
“Thus, since the expectation of consumption is the only raison d’etre of employment, there should be nothing paradoxical in the conclusion that a diminished propensity to consume has ceteris paribus [all else equal] a depressing effect on employment … The absurd, though almost universal, idea that an act of individual saving is just as good for effective demand as an act of individual consumption, has been fostered by the fallacy, much more specious than the conclusion derived from it, that an increased desire to hold wealth, being much the same thing as an increased desire to hold investments, must, by increasing the demand for investments, provide a stimulus to their production; so that current investment is promoted by individual saving to the same extent as present consumption is diminished.
It is of this fallacy that it is most difficult to disabuse men’s minds. It comes from believing that the owner of wealth desires a capital asset as such, whereas what he really desires is its prospective yield.”
In short, if people stop spending, investment will make no difference; the economy will not rebound because people save to invest. Just the opposite: it will sink.
There is also the awkward, uneven, almost embarrassed attitudes of The Treatise on Money, where Keynes measured a “great expansion of corporate saving” in the 1920s — his object of study was the U.S. — which showed up neither as investment nor dividends returned to shareholders. He couldn’t quite figure out what happened to the money but he was right about the problem.
In fact, as of September 1929, a month before the most famous stock market crash in American history, non-financial corporations had billions on deposit at Federal Reserve member banks instead of out on loan to businesses and individuals, and more billions “invested” in the short-term call-loan market that did little but fuel more and more trading on the stock exchange.
But as I keep pointing out when talking about the lack of a need for ever more investment, a “deficiency of investment,” as Keynes called it, just so happened to coincide with remarkable growth of productivity — both non-farm productivity (40 percent) and output (60 percent) in the 1920s.
My answer to what puzzled Keynes in 1930: even then, economies like ours and the U.K.’s had amassed more savings than could usefully be invested. As a result, it fed greater speculation instead.
But back to Keynes and his inconsistencies. His third voice is Keynes the journalist. In fugitive pieces for The Nation and Athenaeum and The New Republic, some of which were collected as Essays in Persuasion, Keynes spoke more freely, more fully, about the new possibilities — the opportunities — residing in the harrowing crisis we call the Great Depression.
His piece in The New Republic of April 14, 1932, was called “The Dilemma of Modern Socialism.” In it, he wondered how the impending end of work — the decline of what Marx had called socially necessary labor — would affect the prospects of growth and the future of humanity as such.
“The chief effect of new machinery … is increasingly, not to make men’s muscles more efficient, but to render them obsolete. And the effect is twofold: first, to furnish us with the ability to produce consumption goods, as distinct from services, almost without limit; and second, to use so little labor in the process that an ever increasing proportion [of the total work force] must be occupied either in the field of supplying human services or in meeting the demand for durable [consumer] goods.”
As a result of this displacement of labor, the sacrifice of saving for a rainy day — of foregoing present consumption on behalf of future growth — had become pointless, and perhaps destructive of the general welfare.
As Keynes put it in 1930 in “Economic Possibilities for Our Grandchildren,” the revolutionary technical changes that had put so many people out of work meant that “mankind is solving its economic problem”; thus it could extricate itself from “the pseudo-moral principles which have hag-ridden us for two hundred years,” particularly from the compulsive accumulation of wealth in the abstract, the love of money as an end in itself, the profit motive as such: “When the accumulation of wealth is no longer of high social importance, there will be a great change in the code of morals.”
“But chiefly, do not let us overestimate the importance of the economic problem, or sacrifice to its supposed necessities other matters of greater and more permanent significance.”
So Keynes, as he worked out his ideas, was of two minds, maybe three. But consistent throughout was his realization that investment out of savings wasn’t easy or automatic. Indeed it was doubtful. Job creation and/or growth did not follow, as a matter of course, from the restriction of consumption signified by saving.
What followed instead was a reduction of demand for goods, unless the banking system immediately transferred savings into loans, an unlikely event in the 1930s and again today. And even if such transfers were immediate, there were always plenty of alternatives to the purchase of plant and equipment that would increase demand on labor: government stimulus programs being the most obvious.
Beyond this, Keynes saw that investment and savings were becoming less important in the grand scheme of economic growth. He saw, in other words, that to the extent that capital-saving innovation had improved on labor-saving machinery–well, in that case, withholding any significant portion of national income from circulation as consumer demand would become a constraint on growth.
And now we get to the heart of my argument: that today’s policy emphasis should be on spending, not saving; in short, my argument “against thrift.”
As an economic historian, I start with history. From the dawn of economic growth until about 1920, growth required more labor time and more investment — more “capital.” As economists now put it, capital/output ratios rose steeply as net investment (net additions to the capital stock, beyond the cost of replacement and maintenance) increased.
Another way to put it is that from roughly 1750 to 1920, growth was driven by saving and investment — by a relative restriction of consumption.
But after 1920, a sea change occurs. Growth happens, rather spectacularly, but without net additions of either past or present labor time. Capital/output ratios fall, accordingly, and so does net investment. So the relative restriction of consumption, which is of course the condition of saving and investment, is no longer the condition of growth.
This is my point, my punch line. It is the historical reality that no economists of the past could address, because it hadn’t happened yet. Only Keynes spotted it, and even he couldn’t be sure.
Like almost all the economic thinkers of the past, John Papola assumes that consumer expenditures represent the destruction of value created by prior saving, investment, and, not least, by productive labor. That’s why his argument carries such a powerful moral charge, and that’s why it remains within the mainstream of economic theory. But, like his compatriots on both left and right, this assumption is precisely what he needs to rethink in view of the historical evidence.
For by adopting it, Papola, like his compatriots on both left and right, covertly reinstates a quasi-Marxist labor theory of value, according to which commodities have more or less value insofar as they contain more or less labor-time, past and present.
But when a greater volume of goods can be produced with less and less labor-time, past and present, because labor-saving technical innovation finally becomes capital-saving as well — again the 1920s are the watershed — then the value of commodities cannot be gauged according to any labor theory; to repeat, the relative restriction of consumption, as against saving and investment, is no longer the condition of growth.
That “when” is the record of economic growth and development since 1920. That “when” is now. And this now is the historical reality that mainstream economists cannot address, because, like John Papola, they’re still acting as if a quasi-Marxist labor theory of value makes sense, so that saving and investment must appear as the self-evident causes of growth.
The exquisite irony of their position needs no further comment. But I would like, in concluding, to note the larger irony Papola has inserted into these proceedings by stating that “growth is created by value-adding production and investment either from the private sector or the public sector, not consumption or consumer spending.” This concession threatens to give up on free market neoliberalism, if not capitalism as such.
Let’s suppose he’s right — that public sector investments “create value” in the same way private investment has always been supposed to: by spending money on capital goods (a.k.a. “infrastructure” in the parlance of public spending on roads, bridges, potholes and the like). The production, installation, and operation of this output then create demand for labor, increasing employment, wages, and, eventually, demand for consumer goods.
By Papola’s accounting, and everybody else’s, this investment comes from a pool of savings that derives, one way or another, from a prior restriction of consumption. In the private sector, we call that pool of savings either profits or retained earnings. In the public sector, we call it tax revenues — what governments force citizens to save by deducting a portion of their income from their effective demand for goods as consumers.
Now, conduct this thought experiment. If Papola is right to blur the distinction between public and private enterprise, then there’s no difference between the forced savings we designate as corporate profits or retained earnings and those we designate as taxes.
In these terms, the popular revolt against increased taxes that seems to characterize the political culture of the last thirty years is a revolt against the saving that governments can impose. In the very same terms, it’s a barely legible manifesto on behalf of consumer sovereignty.
But if Papola is right, why aren’t the American people now in revolt against the forced saving of corporate profits and retained earnings? Is it possible they’ve been influenced by those with the profits and earnings to act against their own interests?
In my view, it is very possible, indeed.
This entry is cross-posted on the Rundown — NewsHour’s blog of news and insight.