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Friday, 30 September 2016

The Importance of Production, Savings, and Investments: A Tale of Two Islands


In order to satisfy our material wants, a sufficient quantity and quality of goods and services need to be produced and delivered that are best able to satisfy these wants. A higher living standard means we are able to satisfy more of our wants, including material wants. To achieve this we need to save and invest in order to produce goods and services to satisfy this end. The more efficient we become at these tasks, the more we’re able to produce and the more we can ultimately satisfy these wants through the act of consumption. By producing and consuming more of what we want and allocating resources in the direction of producing the most urgent wants first and then proceeding down the wish list, we become better off economically speaking. 

It’s the role of businesses to produce goods and services that satisfy consumers’ wants and needs. For these businesses to operate and to improve, they require savings which can be channelled into investments and producers goods which leads to the building up of capital. Capital accumulation means that business can produce not only more consumer goods than before, but also produce those goods more efficiently. This leads to not only cheaper goods and services, but also to higher wages as workers become more productive as a result. [1]

But what sets off economic growth initially? What comes first, the chicken or the egg, or more relevant to the question about growth, production or consumption? This remains an ongoing debate today among economists and in the media, although many appear to have concluded, as can be read every day from some corner of the world, that it’s mostly about consumer spending. “There is not enough consumption”, “too little consumer spending”, or “consumer spending is the engine of growth”, or comments of a similar nature appear to dominate the topic certainly in mainstream media. But the real economists answered this question and put it to rest a long time ago. Here’s a short tale, inspired by Rothbard, [2] Schiff, [3] and others, to illustrate their findings.

Day 1
Imagine a group of ten people getting stranded empty-handed, but with enough fresh water to last them a week or so, on a remote island they decide to name Prosperity Island, or Prosperity for short. A few miles south, another group of ten people get stranded on another island, identical to the other island in all aspects. Like the other group, they arrive empty-handed, except for having enough water also lasting for a week. This group names the island Poverty Island, Poverty for short. Both groups’ consolation price is that both islands have plenty of fish in their waters and coconuts grow in their plenty’s up in the treetops. After a quick trip in the nearby surroundings on the islands, the two groups decide it’s time to catch some fish as all are getting hungry. Without any tools, they jump into the water to catch fish with their bare hands. After the initial scare, the fish returns to the shores and the two groups are able to catch just enough fish to satisfy their hunger.

Day 2
The next morning the group on Prosperity decides to wake up early and hunt hard all day to catch enough fish to last them a couple of days. The goal is to free up enough time to build some landing nets, a much more efficient way of catching the slippery fish. On Poverty, the group lays no plans and continues to catch fish by hand after a long night’s sleep while waiting for happier days to arrive in the form of a rescue. On Prosperity, fishing is not going as well as planned, but they end up with enough fish to last them a day and a half. As it would take two days to build the landing nets, they decide to restrict their consumption of fish so that the fish saved will last for a full two days.

Day 4
Two days later, the nets are completed and all the previously caught fish has been consumed. They go to bed satisfied, though the hunger is starting to creep in once again. On Poverty, life goes on as has now become usual, catching fish by hands to satisfy the hunger for that day.

Day 5
The sun arises once again and the group settled on Prosperity is eager to try out their newly built tools for catching fish. And it’s a winner! After just two hours of work, they have caught enough fish to feed them for the next four days. After celebrating with a few hours of satisfying a most pleasant want, leisure, they decide to make a ladder to enable them to get to the top of the trees to collect coconuts. Their water supplies will run out in just three or four days’ time and now is the time to start preparing. Meanwhile, on Poverty Island, life goes on as usual, catching fish by hand. The better days are yet to arrive as there is no rescue boat in sight.

Day 7
Two days pass and both groups will run out their original water supplies during the next two days. The people on Prosperity have saved up enough fish to last for the next four days and have collected plenty of coconuts filled with rich coconut milk which will quench their thirst at least for another four days after their original water supplies run out. The story is not so plenty on Poverty Island. They have not saved any fish and have not collected any coconuts, and now they’re about to run out of water supplies. They’re left with no other choice than skip fishing, build a ladder and starve for the next two days, the time it takes to build the ladder. On Prosperity, the group has increasingly become tired of sleeping on the ground as it gets quite cold and moist at night. This has resulted in two people taken ill on both islands, which has made it harder than otherwise for both groups to feed themselves.

Day 9
Two days later, the Poverty group has now built the much needed ladder and waste little time in getting to the top of the trees to pick some milk-packed coconuts. As their water ran out a few hours ago, they’re now very thirsty in addition to being starved as they’ve not eaten for two days. Having quenched their thirst, they’re now exhausted. But since they’re starving, the people not taken ill get into the water to catch some much needed food. Over on Prosperity, the group has now completed building a very small and simple, but comfortable hut, lifted off the ground and padded with isolating soft leaves and straws.

Day 16
Another week has now passed, and life is becoming increasingly pleasant on Prosperity Island. They only spend a couple of hours a day catching fish as they’ve built more landing nets. Also, the two that were previously ill and unable to work have now fully recovered as they sleep above the cold and moist ground. Fetching coconuts is the simplest of tasks, though they had to spend half a day repairing the ladder the other day. As they had saved up both plenty of fish and coconuts, the half day spent repairing the ladder didn’t set them back much. They’ve since started building a canoe as they’ve spotted an island in the horizon they would like to explore. Matters are becoming increasingly worse at Poverty and the inhabitants are starting to wonder whether the name they gave to the island have turned out to be a self-fulfilling prophecy. Four more people have taken ill due to the cold and moist ground they all sleep on, leaving just four people to catch the fish they need to eat every day. Also, as the ladder was in a state of much needed repair, it also took longer to collect the coconuts for a few days, a task normally completed in a very short time every day whenever they can find the time. The ladder was eventually repaired by the few left capable of working, but this was at the expense of catching fish. As a result, they all went without any food at all for a few days. Many on the island have started running out of hope, spending much of the day complaining about their unlucky destiny and the lives they could have had if only things were different. Why hasn’t anyone come to rescue us they ponder. Do people not care?

Day 32
Back to Prosperity Island. More than a month has now passed since they first stranded on the island. They’ve now built three new huts giving all more privacy and space. They’ve also built a nice porch in the middle of the small community where they all join at night to spend some quality time together while laying out plans for the next days and the future. The canoe has been built and is ready for its maiden voyage. They face two problems however; they’re getting tired of eating and drinking the same things every day, and they’re having so much spare time they’re getting bored. The group decides to send out a small team to explore the island they inhabit in detail to see if they can find something else eatable on the island. A couple of the people who complain they should’ve fully explored the island earlier decide to get their heads together to find new ways to spend their leisure time.

Day 34
A few days later, the group on Poverty has not eaten since breakfast yesterday. Of the ten people, seven are now ill or in poor condition, leaving just three to sustain the group. As they haven’t had the time or the resources to repair the ladder which by now is completely broken, they’re becoming desperate for a zip of coconut milk. On Prosperity, the team sent out to explore the island has found a spot on the other side rich in not only berries, but also bananas. They’ve also saved enough fish and coconuts to sustain them for a long time and so have more than sufficient reserves in case of disaster. The time is now ripe to put the canoe to work and explore the island in the horizon as they’ve now also built paddles. Three of the group members jump reluctantly into the boat bringing with them a five days of supplies , well aware of the risk the adventure entails. But they agree it’s worth it.

Day 35
All hope now appears lost on Poverty Island. The few people busy feeding the group are becoming worn out and discouraged, not completely unrelated to their realisation that some people in the group are not really ill at all. One got so fed up hearing about their complaints and how hungry and thirsty they were that she left the group and settled by herself on the other side of the island. Later that day, while lying half asleep in the shadows near the beach, a member of the Poverty group stands up glazing towards the ocean. What is that, there is an object of some sort moving out there! They all stand up. A few minutes later it all becomes apparent. It’s a boat! As the trip was substantially shorter than the Prosperity team initially thought, they arrive on Poverty Island with plenty of supplies, enough for a meal for all with a nice big drink of warm coconut milk. After the meal and having shared their stories, the Prosperity team invites the whole group to come and join them on Prosperity Island. We have it all set up there, they explain, we only need to build a few more huts and fishing nets and maybe another ladder. It’s perfect, with more people we can get started on some more projects we’ve been considering.

Day 39 and beyond
After paddling back and forth, all Poverty members arrived safely on Prosperity Island two days ago. The fish and coconut reserves have now been depleted however having been shared between more people and as there were many stories to exchange (and as no work was done for the last two days!). As a result, the Prosperity people cut down on leisure to replenish the reserves and with the help of a few of the people from the Poverty group, they save up enough reserves for all. Over the next weeks, more huts are built, the members of Poverty previously taken ill recover, and the porch for the evening get-togethers is doubled in size. One of the previously demoralised members of Poverty have even set up his own little bar where he indiscriminately serves his newly-invented refreshing barrel-aged blend of coconut milk and specially selected berries from his low-yielding berry farm for the sober price of one fish! As they were never rescued, they all lived happily ever after instead on Prosperity Island, taking frequent holiday trips to Poverty Island where they had since developed a resort with two luxurious bungalows. The resort is today owned and run by the disserting member of the Poverty group. She paid for it with one of her earlier inventions, the wooden semi-automatic fish rinsing machine. These days however she acquires the majority of her fish, berries and coconuts through exchanging high quality, crisp fresh water generated from her newest invention: the saltwater to freshwater distilling machine. 

***THE END***

The story aims to illustrate a few very basic economic principles that represent nothing but common sense and that are perhaps so rudimentary that they are ignored or forgotten about by many economists; the importance of production, savings, and investments. 

With the success story of Prosperity Island fresh in mind, the following economic lessons are readily apparent: 1) there will be nothing to consume if nothing is produced, 2) savings (fish and coconuts inventory) are necessary for both the making and maintenance (repairs) of producer goods (the landing nets and ladder). Production and savings, and the investments they make possible, thus lead to an improvement in living standards as it leads to a higher degree of “wants satisfaction.” A more subtle lesson learned from the tale is that the people on Prosperity Island commenced work that would help them satisfy their most urgent wants, namely find food (fish was the only thing readily available) and water (nothing but coconut milk). They also set about making two producer goods that would help them satisfy these wants in greater abundance and in a shorter amount of time. They could have gone about making something completely useless, such as a pair of skis, but did not do so for obvious reasons. If they had however chosen to make skis instead of landing nets and ladders, or sitting down in study groups discussing how to reduce world poverty, they would have been worse off than even compared to when they first arrived empty-handed on the island. The producer goods they chose to make increased the efficiency of the group. This investment not only freed up time for leisure, but also made the work less physically demanding and perhaps also (more) enjoyable as a result.

Production, the creation of goods or services, therefore precedes consumption, not the other way around. Stated differently, one must first produce what one wishes to consume before one can consume it. This applies to all economies no matter what “stage” the economy is in and its size. If the islanders in the tale above could not become better off straight away through the act of consuming, how can it possibly be that a well-established economy can create economic growth by consuming or consuming more? If consumption exceeds production, it must mean that savings (reserves) are being depleted. This is a process that eventually will have to be ended or reversed when savings have been depleted. Consumption can therefore never, under any circumstances, lead to or fuel economic growth. We work and produce in order to consume, we don’t consume to be able to produce. Nor do individuals consume in order to create economic growth or economic wealth. In simple terms: we cannot consume ourselves to wealth! Quite the contrary, the act of consumption reduces current economic wealth. [4] 

In the above tale, the wealth (fish, coconuts and berries, ladders, huts and fishing nets) could never have been accumulated unless more was produced than consumed. If the islanders were to consume more than they produce, this would reduce this wealth, not increase it. Would you ever advice a family in financial trouble to spend their way out of it? And would you ever advice a financially wealthy family to consume more if its members consulted you on how to further grow this wealth? Of course you wouldn’t. Sure, increased consumption above what current production and savings would allow for [5] in the longer term would require increased production and in this sense perhaps “stimulate” more production and consumption. But what for? And for the benefit of whom? Is it perhaps so that those who don’t produce can consume more? And what if production does not increase as intended? And what about the preference for leisure versus having to work more? Certainly, many people would like to own a house, have a bigger house, or own one located in a better area. But would all sacrifice leisure or something else to earn and have saved enough to afford to acquire and maintain it?

Adam Smith, the Scottish economist, once said “What is prudence in the conduct of every private family can scarce be folly in that of a great nation.” [6] The fundamental message of these words is not altered in any shape or form in a “macro-environment” as “macro” is nothing more than the sum of all “micro.” Macro can hence never be unrelated to the acts of individuals. For an economy to grow and prosper in economic terms, production must exceed consumption (i.e. savings must be accumulated), and investments must be made in producer goods that later must be maintained. There is simply no way around this fact.  Increased debt does a fabulous job of not only halting the accumulation of voluntary savings, but also in steering a part of production away from what consumers would demand, and producers would actually produce, if the strict constraints of valuations as reflected in consumers' and producers' priorities were not distorted.

Note that the statements above have little to say about the general state of people’s “happiness”. People in economies with no economic growth and relatively low material standards of living might very well be relatively “happier” than people living in an economy experiencing tremendous growth from an already high material standard of living. But we do know in general that people prefer more goods to less, that people prefer to consume now rather than tomorrow, and we do know that people prefer not to starve or to be homeless. In short, we know that people prefer to have more of their wants satisfied rather than less and the sooner the better. An improvement in material living standards is therefore important for the majority of human beings. That’s why economic growth is important; it’s simply the only way for society as a whole to accumulate more wealth.


Footnotes:


[1] (Willems, Waiting for Economic Growth Is Wishful Thinking, 2014).
[2] (Rothbard, 2009).
[3] (Schiff, 2010).
[4] The Merriam-Webster online dictionary defines the word «consume» as «to eat or drink…», «to use…» and «to destroy…»
[5] The current state is actually a reflection of people’s preferences.
[6] (Smith, 2003, p. 573).

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