Prague Conference On Political Economy, April 2019

1. Introduction

The standard Austrian economics view about what constitutes saving can be found in many scholarly texts. It begins with the statement that saving is the postponement/curtailing of consumption. The latter statement is beyond reproach but its continuation, i.e. the explanation how saving is transferred into investment is questionable. In particular we will argue that the standard Austrian view on the matter is very narrow, i.e. that it applies only to the very specific case of a barter economy that does not posses capital, i.e. to a basic, Robinson Crusoe type of economy. In a contemporary economy the processes of saving and investment do not require the prior or continuous production of consumer goods.

Once we have shown how saving and investment function from this perspective we will discuss the consequences from the existence of the loanable funds doctrine but this time for a contemporary economy, i.e. for an economy that possesses money and physical capital. Based on this view we will show how capital depreciation can be compensated without net saving on the part of the economic agents. In other words, we intend to show that net saving is not a prerequisite for economic growth.

2. Saving in a monetary, capitalistic economy

In order to reveal the real problem we will make use of the standard example used to introduce saving, namely, the case of Robinson picking-up berries to feed himself. In short it goes like this: Robinson lives on a deserted island and the only way for him to survive is to pick berries from the trees. His problem is that he is not able to get many of them and must work most of his wake time, just to be able to survive. If Robinson had a suitable stick he could pick berries with less effort and therefore, either get more berries in a single day or work less time for the same number of berries he used to eat before. The problem is that in order to create/pick a suitable stick Robinson needs time just for this purpose but this will prevent him from picking berries and he will starve. The way out of this unfortunate situation is for Robinson to save some berries, i.e. to curtail his current consumption and to create over some days a stash of berries, which he could use to sustain himself during the period of stick production. After the necessary amount of berries has been accumulated he creates his stick and becomes much more productive.

We must note several obvious facts. First, the Robinson economy does not posses any capital and second, it does not use money (i.e. a barter economy). In economic terms what  Robinson does can be explained in the following way: He produces the usual amount of consumer goods (berries) for some days but sets some of them aside, i.e. he does not consume them. In a later time period he consumes his saved consumer goods (berries, now considered capital goods) while producing fixed capital (a stick) in the meantime. He invests his effort and capital (stashed berries) into the production of a durable capital good.

This is the simplified view that determines the contemporary ideas what constitutes saving and investment. The problem with it is that it is derived for the most simple, basic case of economy and due to this fact alternative ways to implement saving/investment cannot be observed. In other words: the model used is oversimplified. In particular we note that in order to save Robinson must first produce the berries and just then, when the stashed berries are available can he use them. In a contemporary economy the process of saving includes money however. Thus Robinson would save not berries, but money. However, whereas berries constitute a consumption (or a capital) good, money does not. Money is not used up in consumption or production, it is the ultimate exchange good in fact. Thus when Robinson saves money he does not save consumption goods. In addition, since he has curtailed his consumption (does not spend the money for consumer goods) less consumer goods are being produced on the market as a whole. But what immediately follows is that if he lends his saved money to a capital good producer he does NOT implicitly transfer consumption goods. And the reason is very simple: by not consuming he has decreased the demand for consumer goods and in a short transitional time period the consumer goods produced by the market will decrease in order to comply with (match) this fact. In fact, if Robinson is the only one to save, then the rest of the people will have at their disposal the same amount of consumption goods. Robinson will be the only one in the whole economy who will get less.

What we explained above stays in a stark contrast to the contemporary economic views that Robinson hands out consumption goods to the capital producers for investment. The contemporary Austrian economics views assert that Robinson gives the capital producers consumption goods that they use for paying their workers and for sustaining themselves. Let us quote Ludwig von Mises (1990, ch.4): ”Capital goods come into existence by saving. A part of the goods produced is withheld from immediate consumption and employed for processes the fruits of which will only mature at a latter date”. Or we can quote De Soto (2012, pp.275) (more explicit): ”Saving always results in capital goods, even when initially these merely consist of the consumer goods (in our example the “berries”) which remain unsold (or are not consumed). Then gradually some capital goods (the berries) are replaced by others (the wooden stick) as the workers (Robinson Crusoe) combine their labor with natural resources through a process which takes time and which humans are able to go through due to their reliance on the unsold consumer goods (the saved berries). Hence saving produces capital goods first (the unsold consumer goods that remain in stock) which are gradually used up and replaced by another capital good (the wooden stick)”.

As we explained however, this is simply not the case in a contemporary economy. And the reason is simple: Robinson has decreased his consumption of consumer goods, but instead of these goods being produced first and handed out to the capital producers later (as in the basic Robinson economy) they are simply NOT produced. But something which is not produced (does not exist) cannot be given to anybody. Let us give an example to clarify the situation. In a particular economy the consumers are used to going to a restaurant let us say once per week. Suddenly they decide to eat out once every two weeks. The result will be that if the restaurants have produced X amount of services before they will have to produce half of that amount (X/2) after the change of the consumer preferences. The non-produced restaurant services however simply do not come in existence. But since they are  not created there is no way for them to be transferred to somebody else (i.e. to the capital producers). Note that we have purposefully used services in our example but the same situation can be described with material goods.

3. How saving turns into investment in a monetary, capitalistic economy

Once we explained what the real problem with the contemporary views is we can try to clear up the confusion. Let us figure out what happens in a contemporary economy when Robinson saves money out of his monetary income. The first direct consequence will be that the demand for consumer goods will go down. After some (transitional) time the consumer good producers will realize that the demand has slackened. They will adjust to the new market situation by producing less, i.e. they will curtail the production of consumption goods. What that means is that resources will have to be freed.  In the case of the previous restaurant example this means the following: People will be laid off, buildings will be left free (the restaurants themselves), the capital equipment used for the restaurant business will not be used (bought). In addition intermediate capital goods, such as meat, flour, oil will not be used (bought). Note that the above represents all basic types of capital : original means of production (land and labor), fixed (houses, cooking stoves, tables,etc.) and circular (unprocessed meat, etc.). But let us now imagine what will happen to the suppliers of these restaurants. The suppliers of restaurant equipment ( of stoves for instance) will also realize that their products are not needed. Thus they will also curtail production, again releasing people, production facilities, etc. And their suppliers (of metal parts for stoves) will also have to do the same. And the suppliers of the suppliers (which create the metal for the metal parts) will also have to release resources. What we observe is the following: the initial act of saving causes the release of capital (both original, i.e. land and labor, and fixed and circular one) up the chain of production. A simple change of consumption habits affected all branches that produced intermediate capital goods geared towards the production of consumption goods and services (restaurant services in particular). To summarize what has happened: The act of saving led to a release of capital of all sorts in the industries which were dependent on the production of the particular good, whose consumption has decreased. And this is the capital that can be used for investment afterwards. Up to this moment it was geared towards the final production of consumer goods, but once released it can be geared into another direction, namely towards the production of fixed capital goods such as trucks, oil-tankers, etc. The latter will happen because the saved money will fill the bank coffers (to keep the situation simple). Banks will lower the interest rates and extend credit to producers of durable capital goods. For example, the building of a a new ship yard will be started. Thus part of the resources will flow towards ship building (i.e. labor, building materials, machines, etc.). The needs of the ship-builders will have to be matched by their suppliers however. Thus another part of the freed capital will flow towards the suppliers and later to the suppliers of the suppliers. Thus the capital released will find new uses, all of them with the final goal to produce durable capital goods. Note that the movement of resources does not require additional consumer goods for support during the transition period and after that. The same people who worked in restaurants before will now work in a ship yard (for example). No additional stash of consumer goods is needed. In fact, the overall consumption has decreased permanently and at the same time people who used to work in restaurants in  order to support themselves with consumer goods will now work in ship building. But the amount of consumer goods used by them will be lower, since they decided to save.

4. Accumulation of savings, capital depreciation and growth in a monetary, capitalistic economy

Once we have dealt with the way how saving is converted into investment in a contemporary economy we could deal with the problem how these savings are accumulated and used. For this purpose we will reuse the concept of “Loanable funds” as described in Garrison (2002, ch.3). For our own purposes we will use the name “Investment fund” instead of “Loanable funds”, since it is a better fit to what we intend to show. The investment fund is the amount of free capital present in a contemporary economy that is used for capital substitution and investment. This term must, however, not be confused with the so called “subsistence fund” (Mises 1912).

We start with the simplifying assumption that in an economy with invariable money the only way to save is through the banking system and that banks do not give loans for consumption purposes. This simplification is necessary just for the purpose of explanation and can simply be dropped afterwards, without changing the conclusions arrived in any way. In this simple set up the investment fund coincides with the money lent from banks to producers. This monetary capital is constant in an economy with invariable money and it is being constantly invested and reinvested. The reason why it is constant is because banks strive to protect their capital. In particular they will lend at such a rate of interest and choose their clients appropriately so that they do not lose money. Thus they will generate profit for themselves, while at the same time keeping a constant portion of the monetary supply of the economy for investment purposes. Corresponding to this monetary capital an amount of physical capital will be available, which could be used for investment purposes. It consists of all three basic types of capital, namely, of original means of production (land and labor), fixed and circular capital goods. The latter is due to the fact that banks give loans for hiring labor ( original means of production), for buying machines and buildings (fixed capital) and for buying supplies for production ( circular capital).

What we observed in fact is that from the mere presence of money in the banks it follows that every economy possesses an amount of physical capital which is used for one and only purpose, namely, for capital substitution and investment. It represents a part of the whole economy which exist for no other purpose, but to be invested. This is the so called “investment fund” which is constantly being invested and reinvested. It is the extension of the concept of “subsistence fund” into an economy that in contrast to the one of Robinson possesses capital and money. In contrast to the “subsistence fund” the investment fund includes all possible capital types, not only consumption goods.

Let us now see what the consequences for the economy are. In every economy the amount of capital available and in particular the fixed capital (machines, tools, buildings, etc.) constantly depreciates. In other words this capital wears out and needs substitution if the particular economy is expected to grow. But this substitution can be provided by the available constant size investment fund we discussed. Since it is being invested and reinvested into the economy it can potentially compensate the depreciation. Thus if the investment fund is a big enough part of the economy (measured in money) we can compensate the capital depreciation and the economy can grow.

At present there are two significant Austrian economics views how an economy can grow. In the first one, represented in Hayek (1967), Rothbard (2009) and De Soto (2012) the rate of interest must constantly go down for a sustained economic growth to take place. Thus the economic agents are supposed to not only save but save progressively more with the growth of the economy. In the second, more popular one (Garrison 2002) the rate of interest can stay the same but the economic agents must nevertheless save a constant part of their monetary income. What is common between these two views is that net saving is always necessary for an economy to grow (increasing in the former case and constant in the latter). In fact both theories claim that net saving is necessary in order to offset the existing depreciation. However, as we showed, every economy has an investment fund, which can be used to compensate the worn-out capital. And moreover, that this investment fund is self-sustaining, i.e. it does not require to be supported by additional savings. Thus from the existence of the investment fund it follows that we do not need net saving at all for an economy to grow. The only restriction is for this fund is to be big enough to compensate the existing depreciation. But the size of this fund is under the control of the economic agents. Thus if the investment fund is not big enough we may fill it for some time, until it reaches the appropriate size and then stop saving. In fact we let net saving be positive for some time and then we get it back to zero again. This will happen if for instance consumers decide to save some money, put it into their bank accounts and after reaching their target saving amount stop saving on average. From this moment on the amount of money, which will flow from the banks into the economy (and back) will be enough for capital substitution and investment. In fact the rate of interest will switch to a new, lower, permanent level with net saving zero while at the same time net investment stays positive. On the average economic agents will not save. The saving of some (e.g. young people, saving for retirement) will be offset by the dissaving of others (i.e. retirees drawing down their savings). In fact in an economy with invariable money net saving will simply disappear. All of the above stays in full compliance with George Reisman’s views (Reisman 1990, ch. 15) but described from a very different perspective.

Let us take a look at the process from a mathematical standpoint. We assume that each year 10% of the capital of the economy depreciates. If the investment fund provides less than 10% capital substitution and investment the economy will retrogress, since more capital will depreciate than the one being freshly produced. If the investment fund provides exactly 10% capital investment we will have a stationary economy. And finally if the investment fund provides more than 10% capital investment we will have a growing economy. Thus if we find ourselves in a retrogressing economy with 9% investment we could simply let net investment get positive until we fill the investment fund to over 10% and then stop saving. The latter will guarantee that the economy will be able to grow again.

It is instructive to discuss what would happen in an economy with positive net saving under invariable money. In such a case there would be a constant inflow of money into the banking system (i.e. in the investment fund). Thus the investment fund will constantly grow and tend towards the whole monetary supply of the economy. Such a situation would contradict the well known fact that economic agents are not willing to save indefinitely. In fact, when a particular amount is saved people stop further saving. From another point of view, if we expect the presence of net saving along with a constant amount of money in the banks (under invariable money) then  banks are supposed to lose money constantly.

5. Conclusions

In a contemporary economy the processes of saving and investment are based on money. Thus the availability of a previously accumulated amount of  consumer goods in order make investment possible is simply not necessary. In this way, in contrast to a Robinson Crusoe economy (no capital, no money), investment takes place at the expense of a decrease of the consumer goods production.

We showed that every contemporary economy has an “investment fund”, i.e. an amount of free capital which is self-sustaining and is used for capital substitution and investment. When the size of this investment fund is big enough it can compensate the existing capital depreciation and let the economy grow without net saving being present. In this way we show that an economy supplies the necessary funds for compensating the capital depreciation itself.