Savings versus Investment
This is actually a very subtle issue, because at first blush you’d think the Austrians (adherents to Say’s Law-type reasoning in general) would say that savings always equals investment, whereas those wacky Keynesians would think the two could be different. Yet actually, it is Keynes who insists in the GT that savings necessarily equals investment, and he criticizes the Austrians (as well as other “classicals”) for thinking that “real savings” might fall short of investment spurred on by an artificial boom.
Anyway, that’s sort of a separate thing. Look at Krugman today. Because Obama said foreigners would be more willing to invest in the US if they thought our long-term budget situation were under control, Krugman wrote:
Think about it: U.S. interest rates are low; there’s no crowding out going on; we are NOT suffering from a shortage of saving.
So if foreign investors decide they love us, what does it do? It drives up the value of the dollar, which reduces exports, which leads to fewer jobs.
Does this sound familiar? It’s closely related to the reasons Chinese accumulation of dollar reserves unambiguously hurts the US economy when we’re in a liquidity trap. And what we just learned is that the White House still doesn’t get it.
So hang on a second. I thought–per Daniel Kuehn, but I think he is right–that the problem isn’t too much savings per se, it is not enough investment. So what’s going on in Krugman’s analysis? Obama is saying that both American and foreign investors will be more willing to plunk down investment spending in the US if they are reassured about the fiscal situation.
So why would that make things worse? Take it one step further: Suppose a Japanese investor literally bought US concrete and hired currently unemployed Americans to start building a factory in South Carolina. In order to do this, the Japanese investor would need to use his yen to acquire dollars, in order to buy the American real estate, to buy the concrete, and to hire the workers. So that would push up the dollar versus the yen, and hurt exports, meaning the Japanese investor was hurting the US economy?
Keynes repudiates himself in the GT so many times on savings and investment, it’s a bit pointless to stick him to one definition.
First off, IF as Krugman says we are “NOT suffering from a shortage of saving” then what should we call the drastic underfunding of all the pensions our governments at every level have promised? See, e.g., http://www.city-journal.org/2011/eon0710ng.html
Second, there are only two “actual” forms of saving: hoarding and investment. The difference is that “investment” means trying to increase productive capacity (e.g., by building a factory or some such). When people “save” money they either hoard currency or near-equivalents (a dubious proposition when the central bank is busy devaluing), or they invite someone else to invest the money (in return for “interest” on a loan, or stock dividends, or whatever– a range of possible risks and potential rewards are available). In theory one of the important jobs of banks (“savings banks,” anyway) is to aggregate small savers’ funds and make investments with them–the small savers get the benefit of diversification, the borrowers get the benefit of much reduced transaction costs.
So Chinese hoarding US currency or similar (Treasury bonds), if they are doing that, are “saving” but not “investing.” On the other hand, anyone who actually does invest (that is, in building productive capacity) helps everyone else in the economy along with themselves. Of course some investments will pay off more than others (many will even have negative payoffs)– that is just the free market in action along with the impossibility (for humans) of knowing the future.
Since Krugman doesn’t understand the difference between hoarding and investing (as he also doesn’t understand the difference between investment and government spending, whether by taxation or monetary dilution, on pure consumption), he’s incapable of drawing the correct conclusion, which is that the Chinese (again, assuming he’s right) are doing us a favor by sharing the pain of monetary dilution with us (they have given us tangible goods in exchange for wastepaper–awfully nice of them). Any foreigners who did invest in the US would also be doing us a favor. In the short run Americans would get work building factories or whatever, and in the long run, some of those factories would be successful, transforming their inputs into more valuable outputs and employing people along the way. The fact that a foreign investor might reap some profits would be no skin off our noses–he couldn’t get any profits unless he was satisfying some desire of his customers.*
*I leave aside the special case of factories making things that no one but the government wants, such as ethanol in gasoline. Though the investor participating in a government-subsidized scheme appears to be investing, in fact, he’s really just collecting a political rent– a rake-off on government consumption.
This has to do with a desire to have higher spending -> C+I+G+NX. It is this NX component that Krugman is worried about. Don Boudreaux had responded to Krugman on a related topic
http://cafehayek.com/2011/05/beware-of-celebrating-decreases-in-the-current-account-deficit.html
BTW, does austrians really say S not = I? I thought it was real S=I but planned I is more than S, therefore some longterm projects will have to abandoned at the moment of truth. Mises’s Brick layer example.
Hmmm… well aren’t too much savings and too little investment the same thing (I mean… isn’t that what I say at least?).
I think Chinese accumulation of dollar reserves is somewhat different from a Japanese person hiring in the US with dollar reserves. It’s precisely the same difference between hoarded and non-hoarded savings.
DK I agree. But in this post, Krugman explicitly says that to analyze foreign investors considering the US, we use the same analysis as for Chinese hoarders. So he’s wrong, right?
Or to put it in other words, only if Obama had in mind foreign investors buying US Treasuries, would Krugman’s post make sense. But do you really think that’s all that Obama had in mind? (This is bizarre, I’m defending Obama from Krugman.)
Regardless of what Obama actually meant, I’m pretty sure that Krugman thought Obama was talking about foreigners buying treasuries. But for the record, I do think Obama was talking about treasuries, because throughout the press conference he was talking about how credit markets will view the US.
Only if you think of savings as money and investment as goods. 🙂
well aren’t too much savings and too little investment the same thing
Krugman’s a mercantilist; he’s following the standard equation for calculating GDP (C+I+G+Nx). His reasoning is that if foreigners buy dollars to invest in the US, exports will fall due to a strengthening dollar, and GDP will decrease. What he ignores, however, is that Investment (another component of GDP) will simultaneously INCREASE, bringing about economic growth. Consumption would likewise increase from the stronger dollar, but this would probably be ‘cancelled out’ by the increase in imports (lowering net exports).
It’s amazing to me how many ‘professional’ economists look at the stardard GDP equation and simply assume that raising/lowering one of the components will automatically raise/lower GDP, rather than ‘readjusting’ the other components in turn. For instance, they’ll argue that we simply have to increase government spending (G) in order to increase GDP, while ignoring that doing so will likely lower consumption (C) or investment (I), depending on whether the new spending is financed by taxes or borrowing….
I’m sorry–I pasted in the wrong link (above) to the public pension problem. I should have given you-all http://www.city-journal.org/2011/21_3_public-workers.html
Thinking about the guy on the island with the coconuts. I would consider stacking coconuts to be saving, and my logic is as follows:
* The typical return on investment is 1:1 so spending a few extra hours today gathering nuts and stacking them means you can spend the same hours on a latter day resting.
* The return on investment can be consumed at any time, thus a short planning horizon for the activity.
* The return on investment might be very large because a stack of savings functions as insurance against sickness, famine, etc… so in some cases it could be the difference between life and death (note the element of risk mitigation).
On the other hand, building a fishing net is more in the character of investment:
* Worst case return on investment is a whole lot of effort put in but no fish, thus even starting this project involves taking on risk.
* Typical expected return (if it works as advertised) is better than 1:1 so the fishing net pulls in food faster than gathering coconuts.
* The project requires a longer term planning horizon, perhaps some days spent spinning fibers into yarn during which time no return on investment is possible.
Considering this in terms of liquidity, the half-finished fishing net is low liquidity, all you can do is keep working until it is finished, but the stack of coconuts is high liquidity, because you can stop and eat them at any time.
I also suggest that there is not a clear cut distinction between savings and investment, it is a continuous spectrum because planning horizon is a continuous variable (time) and risk is a continuous variable… or risk vs time vs ROI profile if you want to get into details.