Monday 11 April 2016

Does Saving Equal Investment?

Tax policy in the UK is quite heavily skewed towards encouraging saving. Tax on capital gains is lower than that on income and ISAs and pensions give many tax advantages. The recent budget gave even more benefits to savers than they previously had. In fact, it is a stated aim of the government to encourage saving.

There are a number of reasons for this; one is that these policies tend to reward people who are more likely to vote at the expense of those less likely. A less self-serving motivation for the government is that saving is important because saving means that people will be able to fund their old age and not rely on everyone else.

This argument is, I think, fallacious. In the end, the economy of the future supports those not working, meaning non-workers will always rely on workers. This means that production will have to be high enough to give the required standard of living to everyone. Whether people have money saved up or not only determines the distribution of the future production, not the level.

My saving for my pension means one thing. It means that I will get a larger share of the work of others in the future than I would have received had I not saved. So if anything, it is the people who saved who are a larger burden on those in the future than those who did not save.

This takes us back to the ridiculous (and, time will prove, futile) attempts by the Chancellor to bring the government budget to surplus, as if government debt is an intergenerational transfer from the future to now. As I have said many times, the main ways we can take from the future is by not investing in our productive capacity now, or by damaging the environment. Other than that, all we impact is the distribution of money in the future.

And in that sense, the high house prices (and also other asset prices) due to using monetary policy rather than fiscal policy to boost the economy are a real inter-generational transfer.

In the end, as I argue here, I believe that the decisions to protect savers are very damaging to the economy as they come at the expense of workers; a group whose share of the economy has been falling rapidly over the years, and on whom the economy relies.

But when watching an old Newsnight clip on Frances Coppola's website, I was struck by the comment from the host about government policy:
We must rebalance the economy in favour of saving rather than consumption.
This suggests something virtuous and useful about saving, and Frances goes into more detail. It is the idea that savings are needed for investment.

I would not argue with the idea that the ratio of productive investment to consumption should be higher. If the argument was to rebalance from consumption to investment, I would not disagree. But the quote above is not saying the same thing. It says that we should save more money because it equates saving money with investment.

So, is saving needed in order for us to have money to invest?

I believe the idea that we need individuals to save is a fallacy and to some extent can be traced to Keynes' identity that savings must equal investment. This is true by Keynes' definition, because all production that is not consumed (or presumably just wasted) must either be on investment or an increase in inventories, which is also defined as investment.

But I would say that this is the wrong way round. Investment is, by Keynes' definition, saving. It is work done with expectation of consumption in the future rather than now. But saving money is not investment. Saving money either reduces consumption or increases inventories (which is not my definition of investment).

As an example, supposing I have £100 and my choices are either to save £10 or to buy a quantity of X for £10. The supplier of X can either a) create more of X by using 1 hour of labour, costing £8 and making £2 profit. Or b) she can increase margins on her goods, slightly increasing inflation and making a £10 profit.

In case a) my savings get passed on to the worker and business owner, in case b) my savings get passed just to the business owner. But in both cases the savings still exist. They just get transferred, but now they can be spent again by the recipients and again by the recipients of that money.

All I have done to the economy by saving money is reduced the hours worked by the worker (and future workers down the chain) and thus economic output.

Now ask yourself, who is more likely to invest in increasing future capacity? A business owner with more demand and higher profit or one with less and lower respectively? I would argue that the more people save the less productive investment gets made.

And this result can be seen across the developed world as despite a 'savings glut' we still have low levels of investment.

So where does the money come from for investment? If a company wants to invest then they can do so either with retained profit or by borrowing money. But they do not need to borrow money from savers for this.

Money creation in the modern economy does not require saving in order to produce credit. Banks and corporations are able to create debt (hence effectively new money) at will. Literally no-one needs to save for there to be investment.

Here is an example of  academic literature stating that "over the longer run, higher personal saving would lead to stronger economic growth". They point out that " a country’s saving rate and its investment rate remains large and significant". However, a country's saving rate is not the same as individuals saving. A country with a high saving rate is typically one where wages have been supressed maybe by currency manipulation, tariffs or wage agreements. This means that a higher share of the GDP goes to firms and the governmnent. And typically this policy is linked to a policy of high investment. Because investment is defined as saving then countries with high investment must also have high saving.

But I would call investment 'spending', rather than 'saving'.  And by my definition of saving, the saving rate has been rising over the last 40 years because more and more money, as a share of GDP, goes in dividends and interest payments and less on wages. And the marginal propensity to spend of savers is lower than that of workers, hence the saving rate in the economy is higher (even if the saving rate of workers is lower). By my definition, far more of GDP is saved than 40 years ago, and at the same time, investment has gone down.

For an economy to work well, money needs to keep flowing around it. Savers stop the money from flowing and consequently this lost demand needs to be replaced either with private or public sector debt. If the demand is not replaced then NGDP growth stalls.

The savers can keep the money in bank accounts, effectively removing it from the economy. But what if they invest in shares? Isn't this investment? No, it just transfers the money to other savers. Buying shares in a company is often called investment, but unless it is when the shares are first issued and the money was intended for productive investment, then all it is doing is passing money to another saver and increasing the price of the shares. Ditto for investing in already built property.

Unless money is specifically spent on investment then more saving has a negative effect on investment.

In conclusion, investment is saving but saving is not investment. The reason this can be true is that in the first part I define saving as 'consumption deferred', and in the second part it is just 'saving money'. And the point of the post is that we need to encourage investment or consumption but not saving.


  1. Hello,

    I'm afraid I don't understand. If you saves £10, given how the modern banking system works doesn't this just increases the ability of a private bank to lend "X of money" according to their capital requirements and risk/profit calculations.

    How the bank responds to this in terms of the lending in a productive or unproductive manner is the key for sustainable growth.

    Similarly can you say much re productive or unproductive growth if you spend the £10 directly. For example couldn't your £10 pound two steps on just end up paying down an unproductive loan on say an over price house.

    It seems to me that banks act somewhat like a monetary buffer and it is their choices re allocating credit that is key to sustainable investment/growth or otherwise.

    Recent history suggests they're not very good at this, or (actually my view) their incentives favour asset price bubbles/busts over sustainable investment/growth.

    1. If I save £10 it sits in my account. If I buy something with it, it sits in someone else's account. The final effect of this is the same for the banking system. It doesn't matter to htem if I save it or spend it.

      I agree with you about the banks.

  2. Good post. The economics definition of savings and how it equals investment is widely misunderstood especially since for many, savings is simply money you put in the bank and then the banks will necessarily put it in productive sectors. This is why people get confused as to how there can be too much savings when there is infrastructure to build. It's about time policy makers were clearer on this.

  3. We have about 500 savings schemes, and another 500 schemes to tax us. Think of all the bureaucrats that keeps employed (just to be cynical).

  4. About savings and investment
    what do you think ari?

    1. In this context investing doesn't actually mean real investing. It just means that country A has to borrow 100 from country B.

      This loan could be called an investment.

      It is just a bit confusing that the word investment means both buying shares and bonds as well as actual productive investment like building a factory.

    2. Yes, it is confusing, that's why it is important to be clear. We can't start from S=I identity, which is about real investment, and then use that to analyze what happens financially when a country has excess savings over investment.

      And country A borrowing from country B is just one of the things that can happen. Country A can have excess reserves, whatever they are (target2 balances, gold, country B currency) and simply settle with that.


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