Whether saving funds investment and whether increased saving leads to greater investment is a debate that is as old as macroeconomics, and I have no illusions that I am going to settle the debate or change anyone's mind. In my opinion, there are two sources of problems. First is the implicit assumption that the economy is operating under full employment of resources, which underlies most classical, neoclassical, and Austrian analysis. are major issues most of the problems arise from conflating real and financial flows. Before I begin, I would encourage you to read these two pieces that cover a lot of ground in the debate:
First, some clarifications. Saving is a verb that refers to an act, whereas savings is a noun that refers to a stock.
I am going to start with a rudimentary economy and show that even here increased saving does not automatically translate into increased investment. Take Robinson Crusoe (RC) living on an island and grows corn, which is both the consumption and the investment good. Crusoe grows 100 bushels of corn every period and saves up 20 bushels for seed corn (investment). Here his saving (giving up consumption) is clearly needed for and leads to higher investment. Note that in such an economy, there is no scope for involuntary unemployment. Mainstream economic theories are fine in such cases.
Let us tweak this example a little bit and see what happens if we introduce a little complexity. RC now works for RC Inc, owned fully by RC of course. RC Inc has a capital of 20 bushels of corn (representing RC's past savings, not saving!), worth $20. In addition, there is an RC Bank. RC Inc goes to RC Bank and gets a loan of $80--created out of thin air. RC Inc now hires RC for $80 for one 8-hour day. At the end of the period, RC Inc. sells RC 80 bushels of corn for $80, repays $80, and reinvests 20 bushels of corn. One fine day, RC reads Aesop's fable about the Ant and the Grasshopper and decides to save $20 instead of spending it all. RC Inc now gets back only $60 and has a problem repaying the $80 loan! Note that RC's bank balance is now $20 and RC Inc has an overdue loan of $20. RC Inc has now 40 bushels of corn and judges that RC's demand is only 60 bushels. Given the 12 bushel seed corn needed to sustain 60 bushel net output, RC Inc figures that the next day only 8 bushels of corn need to be planted and he needs RC's labor services only for 3.2 hours. RC comes to work and finds he can only make $32. Paradox of thrift.
Some (especially monetarists and their modern day reincarnations) would argue that this is hoarding of money not paradox of thrift, that desire to save in the form of money is the problem not desire to save per se. Needless to monetarists then go haywire trying to get people to save in real stuff, which gets us a Frankenstein monster. There are two separate decisions that are conflated.First is the decision to forego consumption. The second is a portfolio decision of how to allocate the savings. In order to see how this works, we are going to introduce financial instruments in addition to money. RC Inc issues 20 shares each worth $1--essentially, RC is now owner of public company instead of being a sole proprietor. When RC decides to save $20, he is not necessarily deciding to increase his money balance. He now has a portfolio of $20 in money and $20 in stocks and a portfolio decision to make. He may decide to buy stocks for $20. RC Inc makes a rights issue of one for one. The money now gets transferred from RC's bank account to RC Inc's bank account--there is no hoarding. RC has now 40 shares. RC Inc uses the proceeds to pay back the overdue loan but he is still faced with lower demand. So, he cuts back RC's hours. Paradox of thrift still holds. One difference between the previous example and the present one is that RC Inc is not facing default.
Let us go back to the RC world without all the financial complications but add a new capital good. RC figures that a seed spreader would make his job easier. He now decides to build a spreader. If RC were working full time on growing corn, then the investment in spreader will come at the cost of current production of corn. So, RC has to "save" in the sense of reducing his corn consumption (or having saved up corn in the past) in order to set aside time for investing in the spreader. Once again, we come back to the full employment of resources issue. If RC is not fully employed, the investment in the spreader creates its own saving. Furthermore, saving corn will not automatically create the spreader.
Needless to say the modern world of financial capitalism is incredibly complex and the chasm between saving and investment decisions is wide. Let us go back to saving without hoarding. If people decide to increase their saving while at the same time become increasingly bullish about the stock market, stocks can get bid up and financing for investment can become cheap and readily available. Mainstream economists think that this influence will eventually lead to higher investment short-circuiting the paradox of thrift. However, history shows that investment is demand-led and that business investment decisions are relatively impervious to changes in the discount rate. Moreover, there have been a slew of papers in recent years showing that investment has been much weaker than the Q-ratio suggests. So, one can simultaneously have a boom in asset prices and weak investment--paradox of thrift without hoarding. Redolent of something we have lived through?
Some (especially monetarists and their modern day reincarnations) would argue that this is hoarding of money not paradox of thrift, that desire to save in the form of money is the problem not desire to save per se. Needless to monetarists then go haywire trying to get people to save in real stuff, which gets us a Frankenstein monster. There are two separate decisions that are conflated.First is the decision to forego consumption. The second is a portfolio decision of how to allocate the savings. In order to see how this works, we are going to introduce financial instruments in addition to money. RC Inc issues 20 shares each worth $1--essentially, RC is now owner of public company instead of being a sole proprietor. When RC decides to save $20, he is not necessarily deciding to increase his money balance. He now has a portfolio of $20 in money and $20 in stocks and a portfolio decision to make. He may decide to buy stocks for $20. RC Inc makes a rights issue of one for one. The money now gets transferred from RC's bank account to RC Inc's bank account--there is no hoarding. RC has now 40 shares. RC Inc uses the proceeds to pay back the overdue loan but he is still faced with lower demand. So, he cuts back RC's hours. Paradox of thrift still holds. One difference between the previous example and the present one is that RC Inc is not facing default.
Let us go back to the RC world without all the financial complications but add a new capital good. RC figures that a seed spreader would make his job easier. He now decides to build a spreader. If RC were working full time on growing corn, then the investment in spreader will come at the cost of current production of corn. So, RC has to "save" in the sense of reducing his corn consumption (or having saved up corn in the past) in order to set aside time for investing in the spreader. Once again, we come back to the full employment of resources issue. If RC is not fully employed, the investment in the spreader creates its own saving. Furthermore, saving corn will not automatically create the spreader.
Needless to say the modern world of financial capitalism is incredibly complex and the chasm between saving and investment decisions is wide. Let us go back to saving without hoarding. If people decide to increase their saving while at the same time become increasingly bullish about the stock market, stocks can get bid up and financing for investment can become cheap and readily available. Mainstream economists think that this influence will eventually lead to higher investment short-circuiting the paradox of thrift. However, history shows that investment is demand-led and that business investment decisions are relatively impervious to changes in the discount rate. Moreover, there have been a slew of papers in recent years showing that investment has been much weaker than the Q-ratio suggests. So, one can simultaneously have a boom in asset prices and weak investment--paradox of thrift without hoarding. Redolent of something we have lived through?
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