Monday, 23 February 2015

A Note on Natural Economic Growth and The Role of Savings

Natural economic growth, or a rise in living standards, which we might also refer to as sustainable economic growth, comes about as a result of production, saving and investment. Savings can only accumulate if less is consumed (spent) than is produced (earned). Real saving therefore cannot be generated through inflating the money supply as both assets and liabilities increase simultaneously when it does. Taking up a loan and depositing it in a savings account therefore does not qualify as real saving. 

The higher savings are in relation to consumption, which we may refer to as the consumption/saving ratio (C/S), the more resources become available for investments. As saving and investment are both necessary for real economic growth to take place and as there can be no investment without saving, the lower the C/S ratio, the higher the potential economic growth. Conversely, the higher the C/S ratio, the lower potential growth becomes. Less consumption and more saving hence bring about more output in the future. 

Increased saving available for investments also brings with it the added benefit of naturally pushing the interest rate on loanable funds lower than would otherwise be the case. This reduction in interest payments will by itself make more investments profitable than otherwise as the break-even point for businesses and projects decreases. As producer goods accumulate and become more advanced, businesses and labour become more productive, the supply of consumer goods increase and their prices decline. As a result, real wages increase, raising overall living standards with it. This process allows future consumption to increase. Better yet, it's sustainable.

It should come as little surprise that in the U.S. and many countries around the, the reverse is taking place. A fundamental message underlying Say's Law in my opinion, that we need to produce before we can consume, is instead turned upside down driven by a political doctrine hoping that growth starts and end with consumption. 



Combined with an ever expanding money supply,


such policies can only lead to to false booms and very real busts and an ever decreasing purchasing power of money for the majority. 


Ultimately, consumer spending falls as previous levels of expenditures are unsustainable because people simply can't afford it any longer. 

The standard policy solution to this problem? Start the whole cycle once again: create more money and induce consumers to spend more. Just how it is actually feasible, or even possible even in theory, to cure something with what caused it in the first place remains a bit of a puzzle....


Also see: