To recap
yesterday’s lesson in Keynesian finance, limiting the source of financing for
new capital formation to past savings not only diverts funds away from
consumption (thereby nullifying Adam Smith’s first principle of economics, that
production is for consumption), but in order to have production that is not
intended for consumption generate the savings necessary to finance new capital
and create jobs, demand must be artificially added to the economy so that goods
not intended for consumption can be consumed. Yes, we are fully aware that is a contradiction. Keynesian economics relies on such things.
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| Goods produced for non-consumption must still be sold to save. |
Of course, as
Harold G. Moulton pointed out, if you don’t add demand artificially to the
economy when you save for reinvestment, then the production set aside for reinvestment piles up unsold, cutting
demand, and instead of sending the economy into a disastrous inflationary upward
cost-price spiral, sends it into a disastrous deflationary downward cost-price
spiral.
. . . as long as
you rely on past savings to fund both consumption and new capital investment,
that is. This, as Moulton expressed it,
presents the economy with an “economic dilemma.” As he put it in Chapter II of The
Formation of Capital (1935),
The dilemma may be summarily stated as follows: In order to
accumulate money savings, we must decrease our expenditures for consumption;
but in order to expand capital goods profitably,
we must increase our expenditures for consumption. The proposition may be
made clearer by once more contrasting the roundabout process with the direct
process of relatively primitive agricultural communities. When a pioneer farmer
created capital by the direct process he did not need to curtail consumption in
order to obtain funds with which to increase his capital; he merely devoted his
energy; in off seasons, to the improvement of land or to the construction of
fences or buildings. But under the modern system of specialized production and exchange
the pecuniary savings of individuals are in the main necessarily at the expense
of consumption. If an individual with an income of $2,000 elects to save $500
he reduces his potential consumption by one‑fourth. Moreover, the aggregate of
individuals who make up society must in a given time period restrict aggregate
consumption if funds are to be provided, out of savings, for additional capital
construction.
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| Production is immediate, profits are long term. |
It should be noted, also, that when creating additional capital in
the form of improved land, buildings, or tools, the primitive farmer was not,
immediately speaking, confronted with the question of money profits. The
improvements made appeared to add directly to the value of his property
holdings; and the increased output which might result from the improvements
could presumably be used by the farmer himself or sold in the market. In any
event, he was not concerned with the payment of dividends or interest on
borrowed funds. He was dependent solely upon himself, and the additions to
capital equipment represented the direct fruits of his own labor.
In contrast, when the managers of modern business corporations
contemplate the expansion of capital goods they are forced to consider whether
such capital will be profitable. They must begin to pay interest upon borrowed
funds immediately and they must hold out the hope of relatively early dividends
on stock investments. To be sure, there are certain types of speculative
enterprise in which capital will be risked for considerable periods of time in
the hope of large ultimate profits; but, in the main, returns have to be in
prospect relatively soon.
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| As technology advances, profits become more immediate. |
Now the ability to earn interest or profits on new capital depends directly
upon the ability to sell the goods which that new capital will produce, and
this depends, in the main, upon an expansion in the aggregate demand of the
people for consumption goods. A particular corporation may, to be sure,
construct new plant and equipment in the face of a declining aggregate demand
from consumers, hoping by lower costs and price concessions to take business
away from competitors, whose capital will thereby be rendered obsolete; but if
the aggregate capital supply of a nation is to be steadily increased it is
necessary that the demand for consumption goods expand in rough proportion to
the increase in the supply of capital.
To summarize, if
people save (i.e., cut consumption)
to invest in new capital formation, they no longer have any reason to finance
new capital formation because the consumer demand that would justify it does
not exist. If people spend but don’t
save, then there isn’t sufficient savings in the system to satisfy the demand
for new capital that derives from consumer demand.
. . . as long as
you rely on past savings to fund both consumption and new capital investment.
The solution to
this seeming paradox? Future savings,
which we’ll look at tomorrow.
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