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 deal with the problem how savings are accumulated and used in a contemporary economy, i.e. an economy that possesses money and physical capital. We will show that every economy has an “investment fund” of capital which is used for capital substitution and investment. Based on this view we will also show how this fund can be used to compensate the capital depreciation, thus avoiding the necessity for 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 implicitly 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 new ship yard will be started. Thus a 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 no additional consumer goods for support during the transition period and during the time necessary for the production of the ship-yard are required. The same people who worked in the restaurants before will now work in the ship yard (for example) and since they are employed and paid they can provide for their own existence. No previously accumulated stash of consumer goods is needed. The overall production of consumer goods has decreased permanently and that is why the consumption of the workers from this moment on will be lower. They have in fact voluntarily agreed to consume less than before the transitional process took place.

Note that the above-given description is simply a description of a transition of an economy which moves from producing less to producing more durable capital goods. How secular growth happens and what the differences are will be handled in the subsequent part of the paper. Still, we must note some significant differences when comparing the discussed process to the one present in the simple Robinson Crusoe economy. In the Robinson case (no capital, no money) we need to produce consumption goods first and only then can we start the production of new capital goods. In a contemporary economy however this is simply not necessary. The intermediate step (producing consumption goods for sustaining Robinson) is simply passed over. What this shows is that the contemporary economy is much more effective in using the available capital. In particular less capital will be used (just the one necessary for the production of the final durable capital goods) and much less time will be needed (no time for the production of consumer goods is required). A contemporary economy has more degrees of freedom than the basic Robinson Crusoe economy. It has a capital structure and money, i.e. additional ways for capital redistribution exist. In other words a contemporary economy is much more flexible and effective with respect to capital transfer and capital usage.

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.

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. At present there are two significant Austrian economics views how an economy can compensate and overcompensate this loss of capital so that economic growth becomes possible. 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. What this means in practice is that both common workers in companies and the businessmen who run these companies must put a part of their monetary income either in a bank account or in another saving option (for instance by buying company bonds or shares). The latter must happen on the average (i.e. not everybody needs to save) and must be continuous (i.e. saving never stops).

We intend to discuss what the consequences from the above-given view are for a banking system in an economy with invariable money. We will further accept that under invariable money the banking branch of the economy functions in the same way as any other economic branch (i.e. retail, ore-mining, etc.). In other words, we will presume that the conclusions we derive for the banking system will apply to the other branches of the economy as well. The reason why we have singled-out banking is that the processes we will describe are simpler to observe and clearer there from an economic standpoint.

Banks always have some amount of own capital, but most of the capital comes from outside, i.e. from savers who entrust the bank with the task not only to protect the amount of money they have put in it, but also to increase it (i.e. they expect to be paid interest on their bank account balances). Banks on their side lend the money they have obtained against interest. They are motivated to protect the monetary capital they have and therefore they lend it at such a rate of interest and choose their clients in such a way that they generate profit. Thus on the average the capital in the banks does not decrease. What this implies is that whatever capital is being lost ( e.g. bad loans and bank capital depreciation) will have to be compensated. And it is being compensated from the banking revenues. Revenues however are not savings and do not have a savings component in themselves! Thus what we observe is that capital loss compensation in banking does not require net saving. Let us however assume the contrary and see what follows from it. Thus we must presume that bank capital depreciation must be compensated by additional saving on the part of the banking clients. Savers however will expect that the additional money they put into their savings accounts is also protected, i.e. they will expect that their money does not decrease, i.e. that it is not lost. If this was not the case they would simply withdraw their money from the bank. But the latter would imply that the additional savings cannot be used by the banks for compensating the depreciated/lost capital. What is more, for steady growth in time we must presume that savers never stop saving. Still, reality shows that savers save for something, i.e. when a particular amount of saving is reached people stop saving on the average. All of the above leads us to a contradiction, which implies that our initial supposition is not correct, i.e. that the depreciated/lost capital in banking is not compensated by net saving on the part of the economic agents. What this shows is that this branch of the economy can protect its capital without the need of net saving in general. In this way capital depreciation losses are shown to be identical to the general capital losses (due to bad management decisions, economic disasters, bad luck, etc.). Both types of losses are being covered from the revenues of the (successful) companies.

The rest of the branches of the economy however are not supposed to work differently under invariable money. Thus in them capital depreciation will also be compensated by their revenues. From here we can generalize that since an economy is in fact all economic branches taken together and since no net saving is required in any branch, then net saving is not necessary for the existence of the economy in general. In other words, net saving is not necessary for compensating the economy – wide capital depreciation. The capital depreciation in an economy is compensated from the revenues of the companies but revenues represent expenses from the point of view of the clients of the particular companies (i.e. consumers and business). Expenses however do not constitute savings by definition. Thus to claim that net saving is necessary for an economy to grow equals the claims that either capital losses/depreciation on a micro-economic level is not compensated by the companies’ revenues or that sales revenues are savings (or at least have a savings component in them). The former would imply that companies cannot exist without constantly taking loans which are never repaid and therefore that the savers who provide these loans accept this situation, i.e. that they agree simply to give out money for nothing. The latter would imply that economic agents can save by spending money!

Once we have dealt with the net-saving issue we can discuss what the source of capital used for compensating the capital depreciation is. In an economic system with invariable money every piece of money which is not hoarded, i.e. every piece of money used for economic purposes must have a corresponding economic resource in the real economy (the latter does not apply to an economy with a growing monetary supply, as is the case nowadays; Cantillon effect applies). Since money is used for exchange, then against each dollar which has been spent stay either capital goods (for businesses) or consumer goods (for consumers). Since in a growing economy companies have an excess of revenues over their costs then this excess amount of money combined controls a significant part of the real resources of the economy. Here under costs we understand the expenses of the company for original factors of production (land and labor) and for circular capital only. This excess of revenues over the particular costs has three types of use. First, businessmen use part of it for personal consumption. Second, they use another part to compensate their lost/depreciated capital and third, they use the rest for further investment. It is in fact hard to distinguish the latter two types of use from one another. Still, as we see, against the money used for capital compensation and investment stays a significant part of the economy. In other words, every economy has a part which is used for no other purpose but to compensate the depreciated capital and provide further investment. The economy provides for its own needs at no expense of the economic agents (i.e. no net saving). The latter happens since the durable capital goods, which the economy produces, compensate and over-compensate the worn out/depreciated ones. From now on I will call this amount of capital, used for capital substitution and investment the “investment fund”. In contrast to the “subsistence fund” (Mises 1912) the investment fund consists of all types of economic resources, not only of consumer goods. The investment fund includes all three basic types of capital, namely, original means of production (land and labor), fixed and circular capital. The latter can be observed when one realizes 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). The “investment fund” is self-sustaining and it is being constantly 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.

It follows from the requirement to have a growing economy that the investment fund must 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.

We could now contrast what we explained above with the transitional process we described previously. During the transitional process net saving was present and it lead to re-directing resources from lines of production leading towards final consumer goods to lines of production leading towards durable (fixed) capital goods. A shift of capital towards the investment fund happened. During the process of secular growth described above no net saving is present but still net investment exists. No capital is shifted in or out the investment fund but still the economy grows because investment in all lines of production is present.

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 to make investment possible is simply not necessary. In this way, in contrast to a Robinson Crusoe economy (no capital, no money), saving-induced investment takes place without producing consumer goods first.

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.