The U.S. Needs to Save More and Invest More – Annals of Economic Idiocy, Part I

Fighting Economic Illiteracy One Idea at a Time

[Editor’s Note:  Conventional Wisdom has it that as the population in general and Policy Makers in specific have become more educated and more experienced over time, they would have more intellectually consistent and accurate thoughts on economics and economic policy.  Alas, this has not proven to be the case. Hence this series of articles]

Those who would proscribe a cure for what ails the American economy have often stated that the U. S. needs to stop “borrowing and spending” and engage in more “savings and investment”.  This is an appealing message, as the Puritan heritage of the country decries borrowing and spending, and the actions of saving and investment seem economically desirable and morally pure.  Unfortunately the world of economics does not work this way.

Anyone who proscribes a policy of “saving more and investing more” lacks a fundamental understanding of how a modern economy works.  Specifically, they do not understand that the primary driver of investment is consumption.  The demand for investment goods is what is termed “derived demand”, that is, the demand for plant and equipment and investment in training, and purchases of information processing items is not driven by direct demand for what those things can do.  It is driven by the indirect demand for the increased output or increased productivity associated with them.

Business will invest when it needs to increase capacity to meet the demand for increased spending or to offset cost pressures when production goes beyond its minimum cost point.  This incremental investment comes from increased Aggregate Demand for goods and services.  Savings decreases Aggregate Demand for goods and services.  So the logical conclusion is that increases in savings will result in lower, not greater investment.

Those who advocate reducing demand for example by reducing government expenditures apparently believe in what is termed the “confidence fairy”.  Under this theory, when governments reduce spending to improve their fiscal position, business confidence rises and business initiates increasing investment spending.  The only problem with this theory is that it does not happen.  Contractionary fiscal policy in England, Greece, Ireland, Spain and Portugal have all produced lower private spending, higher unemployment and less economic growth.

The U. S. economy will have a sustained recovery when there is less savings and more investment. Investment has two impacts on ecnomic activity compared to consumption.  Incremental consumption of $1 million, for example produces initial incremental income of $1 million.  Incremental investment of $1 million prodces initial incremental income of $1million, plus increases in capacity and efficiency. But this benefit from investment must come from cnsumer spending, or in its absence Government Stimulus programs.  Public officials, office holders and candidates that propose increased savings will lead to increased investment are just dropouts from Econ 101.