Friday, October 21, 2011

Why Saving Is Good (For Everyone Except the Saver) Pt 1

We hear a lot of talk about how, in order to get out of the current economic slump, we need to “stimulate demand”.  The “demand-side” economists love programs like food stamps and unemployment benefits, because the recipients of these benefits “spend the money right away” and the people paying for these benefits might, god forbid, save the money instead of spend it. 

This is a particularly tricky fallacy because its underlying assumptions are actually mostly true.  The first assumption is that spending money is good because it creates value, which is true, and the second assumption is that saving money does not directly create value, which is also true.  The fallacy comes in when one assumes that because saving money does not directly create value, there is no benefit to society when you do it, and so it is justifiable to tax money from those who might save it and give it to those who we know won’t.   As Barack Obama once put it, “there are only so many yachts you can buy,” so it can be beneficial on net to tax the rich and give to the spendthrift. 

The problem is that the benefits of spending are obvious and direct—the benefits of saving are not so obvious and not so direct.  But they still exist. 

Let us first reframe the discussion so it is easier to understand.  When you earn money, you are giving someone something they value—carrots you grew, lattes you brewed, work you did—and in return you are getting money.  You can then exchange the money for something you value—a DVD player, a cleaning service, a taxi ride.  When you earn money, you are acting as a producer, when you spend money you are acting as a consumer.  The money itself doesn’t mean anything—it’s low in protein and carbohydrates and doesn’t offer much entertainment to look at unless you happen to be Scrooge McDuck.  What matters are the things of value that the money can be exchanged for, not the money itself. 

So what is a saver?  A saver is someone who earns he does not spend; someone who produces more than he consumes. 

How does that benefit the rest of us?  Well, to simplify, imagine a deserted island on which a small group of people—Bob, Alex, Jill and Rita—get stranded.  They all divide up their duties—Rita collects the water, Bob hunts for food, Jill builds the shelter and Alex makes the fire—and they all share the benefits by drinking water, eating food, sleeping under the shelter and getting warmth from the fire. 

But what happens if Rita decides she is going to be our “saver”?  She does what the saver does in the real world—produces without consuming.  Rita continues to collect the water, but she eats less of the food, drinks less of the water, doesn’t sleep in the shelter and does not warm herself by the fire.  This leaves more food, more water, and more space in the shelter and by the fire for everyone else.  Rita is worse off but Bob, Alex and Jill are better off.  They are getting more for the same amount of work. 

The same thing happens in the real world, but it’s much more difficult to track, given the vastness and complexity of modern economies.  Still, the principle is the same.  If I decide I am going to keep doing work, but save most of my income, I am doing the same thing Rita is doing on the island with the same effect.  I am producing more than I am consuming, and everyone but me is better off for it. 

The way saving benefits others in our modern economy is slightly different, though, and, as I said before, more indirect.  By not spending the money he earns, the saver is, in effect, reducing the money supply.  This makes everyone else’s money ever so slightly more valuable (it’s the opposite of what the Federal Reserve does.)  It seems insignificant, but if 10% of all the dollars floating around in the economy were taken out of circulation by magnanimous savers, each dollar you earn would buy 10% more—that’s like a 10% raise without any extra work on your part! 

Saving, as we see, is redistributive in and of itself.  There is no need for the government to get involved by taxing away money that might be saved and giving it to those most likely to spend.  The savers are doing that—indirectly—themselves, by reducing prices for everyone else. 

But we aren’t just choosing between two different yet equal methods of redistribution.  One is clearly worse.  If we presume that the savers are rational people, as we always must, we can assume that they are saving for a reason.  Perhaps they are putting money away for their retirement or their posterity.  Perhaps it is going towards some future ambition.  Whatever the reason, they get some benefit out of saving. 

When the savers are allowed to keep their savings and the spenders benefit from more valuable dollars, the savers and the spenders both win.  The savers get to save and the spenders get to spend.  When the government taxes savers and lavishes spenders, the spenders win only insofar as the savers lose.  There is no net gain for society, just one group benefitting at the expense of another. 

What we always need to remember is that, when we are talking about government, there ain’t no such thing as a free lunch.  We should always prefer to see a rising tide lift all boats than to play a zero sum game. 

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