More Thoughts on Saving

In our society we are taught to view saving and thrift as virtues. But is that really a rational perspective? Consider this excerpt from The Economics of John Maynard Keynes by Dudley Dillard (1948):

Specifically, let’s focus on this part: "Attempts to save, which are successful so far as the individual in concerned since he adds to his individual wealth, may be self-defeating and even positively harmful so far as society at large is concerned."

To illustrate this point, imagine the most basic, primitive economy possible -- two individuals living on an island with two economic goods -- Food and Drink. Let's say that both individuals consume 10 units of Food and 10 units of Drink per day and that working separately it takes them 12 hours a day to produce those quantities.

Now let's imagine that they discover the principle of Division of Labor. In other words, they realize that they will both be better off if each of them specializes exclusively in the production of one of the two goods they need and they then exchange their excess produce for the good they don't produce for themselves. Now, instead of both individuals working separately to produce both Food and Drink, Individual #1 works exclusively on the production of Food and Individual #2 devotes himself solely to producing Drink. Let's say that by doing so (and thereby improving the efficiency of their productive processes), instead of having to work 12 hours a day, they are now able to produce enough Food and Drink working only 8 hours a day. Each of them can now decide how to he wants to employ the 4 hours a day that have been freed up by the Division of Labor. One might choose to relax on the beach. The other might choose to manufacture a luxury good, like a hammock. In any case, they are both clearly better off as a result of the Division of Labor than they were when they each had to provide for their needs individually.

Now let's say that rather than exchange their goods directly they decide to invent money. (Of course there would be no need for money in such a basic economic system, but for the sake of illustration let's imagine they invent it anyway.) Let's say they mint 20 Island Bucks and divide them up equally. Now they meet once a day and Individual #1 gives Individual #2 ten Bucks for the Drink he needs, and Individual #2 gives Individual #1 ten Bucks for the Food he needs. Under these circumstances, the economy is in balance.

Now let's imagine that Individual #2 has the brilliant idea of saving. He decides he can "tighten his belt" and survive on only 8 Bucks worth of Food per day. He reasons that he will be better off by doing so, since he can set aside the other 2 Bucks for a rainy day, for future investment, for leisure, or whatever.

What would the consequences of this act of saving be? Obviously it would quickly become clear that saving is self-defeating under these circumstances, since as a result of choosing to spend only 8 Bucks on Food, Individual #1 will now not have enough income to buy all 10 Bucks worth of Drink that Individual #2 produces. So, whereas Individual #2 imagined that he would be better off as a result of saving, he actually only managed to impoverish Individual #1 AND HIMSELF.

This example illustrates how "attempts to save… may be self-defeating and even positively harmful so far as society at large is concerned."

Lastly, let’s think about how Individual #2’s decision to “save” would look if they hadn’t decided to invent money and instead relied on barter.

The concept of the Division of Labor contains an implicit agreement to cooperate. The two individuals can only afford to stop producing both goods for themselves if they can be sure that the other will be willing to make an exchange. In the absence of this agreement, it would be suicide for either individual to stop producing both goods.

What would Individual #2’s decision to “save” look like in a barter economy? It would simply mean that when the two meet up to make their exchange, instead of offering 10 units of Drink, he only offers 8. Obviously this would be an irrational violation of the implicit agreement underlying their decision to divide labor. It is only the introduction of money that makes it possible to lose sight of the irrationality of “saving” under these circumstances.

This hypothetical example sheds light on the assertion that “spending rather than individual saving is the essential condition of production and prosperity in an exchange economy where one man’s spending is another man’s income.”