Saturday, May 5, 2012

the economic distinction between Savings and Investment

The importance of this topic is relevant to the economic multiplier effect and the waste of money's time (discussed recently).

Investment, to deviate slightly from Wikipedia, is total business spending excluding financing cashflows.  It is Expenses plus plant and equipment purchases.  It is not financial holdings.

Savings is money that is not spent or invested.  While these definitions are simple and clear.  It describes Savings as completely different and separate from Investment.  "Investing" in the shares of a company by buying them form some other shareholder is Savings.  Even trading your savings to a company (for,say, some of its shares) such that it holds them in their bank account is still savings.

Classical Economists viewed savings and investment as equivalent, under the presumption that Savings is available funds for Investment, and so Savings will eventually be invested or spent.  The predominant view was that to increase Investment, you simply had to increase Savings, and this would allow bankers to lend to businesses at lower rates and thus increase investment.

A good critique by James Kroger led to his following formula for investment: Investment = (some % of Savings not used for Consumption) + (the corporate earnings that finance 85% of Corporate Investment) + (newly created money by the Fed deposited in banks)

There are a couple of problems with this model.  First, not all money created by the Fed is invested.  Most of it, in the 21st century, is placed in financial instruments by the Fed's member/client banks.  Second, while Investment does depend on the availability of consumer and corporate savings, there is no rational investment decision process that allocates a percentage of Savings to be invested.  Rather,

Investment = Those good ideas that cost less than available savings (and available money creation capacity), which in a wealthy economy is usually simplified as all good ideas.  A good economic idea has a simplified definition as one that will likely be profitable relative to holding financial instruments.  Investment has pull (good ideas) and push (available money) components, but the availability of money/savings is not currently a relevant constraint.  

A structural shift that is and will continue to plague the economy is the reduced need for labour.  The growth companies/industries require much less labour than companies of 20-100 years ago did.  Google's self driving car and other innovations will also reduce the need for labour.  These structural shifts mean that good ideas of today and tomorrow do not employ as many people as good ideas of yesterday.  The combination of this structural shift with the 2008 realization that building/owning a home is no longer considered a good idea by banks causes a very large surplus of uninvested savings.  Low employment, and accompanying lower demand, means that there are fewer opportunities for good ideas

Before I list ideas to stimulate investment, let me make you read through multiplier theory.

The Economic multiplier is the amount by which any spending or investment is respent/reinvested.  Though difficult to quantify precisely,  A multiplier number represents the amount of times a dollar is spent and respent in one year.  It is usually discussed in the context of Government spending as a justification for some spending programs over others, but its effect applies to all spending.  If you can double an economy's aggregate multiplier effect, then you will double its total economic spending and activity (GDP).

An economic multiplier of infinity is theoretically possible if there is no savings, and no constraints on labour, production and resources.  While no savings, means impossible instantaneous spending, if all funds are spent after being held one day, it would create a multiplier of 365.  These 3 constraints represent the 3 wastes discussed in the economic justification of taxes.

The simplest rule that follows understanding of the multiplier is that paying money to people who will save it a very short time prior to spending/investing it (generalizeable as the poor) always creates more economic activity/social benefit than paying that money to a saver (i.e. rich), because saving halts the multiplication effect of that spending.  The second rule is that all money eventually trickles (back) up to a saver 

Promoting Investment and good ideas
Since wealth naturally trickles up, the key to promoting investment is to make it trickle back down.  We can imagine a world a few decades away, where machines make everything, and a very select few own all the machines.  The machines are only useful if there are people available to consume their product, and so it is only a good idea to invest in the machines if those customers will exist.  Recommended programs and policies:
  • Wealth redistribution though taxation, basic income, and social dividends.
  • Unfiltered, unpoliticised, wealth redistribution (basic income) is a far preferable system to ensure social harmony, than military/police/prison spending purposefully inflicting unhappiness on citizens.  It also frees up people's time to pursue something productive.
  • Unpoliticized wealth redistribution so that taxation cannot be claimed as theft used to fund winning political special interests.
  • Relatively high corporate tax rates, combined with a tax code that simplifies receiving tax rebates for losses, such that investing in (good) ideas is less risky.
  • Tax deductibility of corporate dividends so that corporate savings in excess of their future good ideas are redistributed to those who will spend or fund good ideas.
  • High marginal personal tax rates, but with top marginal tax deductibility for investing and income splitting through personal services.
  • Tax code incentives that encourage flow of funds into the economy through exports and imports.
  • Reduce the need for savings and improve labour's health, productivity and competitiveness through universal healthcare.
  • Natural finance structured organizations that foster investment and ventures with less required cash.
  • Renewable energy production sufficient to drive down energy prices such that indoor agriculture, and other good ideas become economically viable.  This would furthermore occupy people's time productively, and support higher populations.

The tax code proposals are the heart of Natural Taxation policy.  The necessity of an egalitarian-based wealth redistribution mechanism is only partly based on a future that lacks employment opportunities based on technological productivity and on stabilizing population.  The other justification is preventing social unrest that results from directed politicized assistance.  The power of older demographic groups manifests the 2 wolves and a sheep democratically deciding what is for dinner problem, and in fact Canadian politicians without any financial crisis are already dismantling benefits for younger generations.

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