This Is How Savings And Investment Pave The Way For An Advanced Economy

By U Cast Studios
August 14, 2021

This Is How Savings And Investment Pave The Way For An Advanced Economy
Image Courtesy Of Mises

To maintain his life and well-being, an individual must have at his disposal an adequate amount of consumer goods. These goods, however, are not readily available. Without tools at his disposal and by means of his bare hands, the individual can only obtain from nature very few goods for his survival.

This article was written by Frank Shostak and originally published by Mises.

For instance, take an individual John, stranded in a forest. In order to stay alive, he can only pick up some apples from an apple tree. Apples are the only good available to him that can sustain him. Let us say that by working twenty hours a day, he manages to secure twenty apples, which keep him alive. The twenty apples that John has secured from nature is his subsistence fund, which sustains him (see also on this Rothbard)[1].

John realizes that if he had a special stick this would allow him to become more productive. His daily production of apples could be forty apples (i.e., double his current production). The problem, however, is that the stick is not available—it must be made. To make the special stick requires two days of work. If John were to decide to make the stick, he would have a problem. By spending his time on making the stick, he would not be able to pick up the apples that are required to keep him alive.

The only way out of this predicament is for John to put aside an apple a day for the next forty days. By saving an apple out of his daily production and enduring hunger, after forty days he will have an adequate stock of apples that will sustain him while he is busy making the stick. (We make the unrealistic assumption here that apples can be preserved in edible form for forty days). Thus, after forty days, the John’s subsistence fund will be comprised of forty apples, which will see him through while he is making the special stick. We can see here that the saved or unconsumed forty apples enable the making of the stick, which raises the production of apples and lifts John’s living standard.

Note that the making of the stick is a burden—John has to make a sacrifice and save forty apples thereby endangering his health and well-being. However, the stick will allow him to double his production of apples. If he continues to consume twenty apples a day, this will allow John to increase his subsistence fund. With a larger fund, John could consider allocating his time to make some other tools to enhance his life and well-being.

The state of the subsistence fund determines the quality and the quantity of various tools that can be made. If the fund is only sufficient to support one day of work, then the making of a tool that requires two days of work cannot be undertaken. The size of the fund sets the limit on the projects that can be implemented. It also means that the size of the fund determines the so-called economic growth.

According to Richard von Strigl

Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides labourers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs for a period of one year…. The greater this fund, the longer is the roundabout factor of production that can be undertaken, and the greater the output will be. It is clear that under these conditions the “correct” length of the roundabout method of production is determined by the size of the subsistence fund or the period of time for which this fund suffices.[2]

The essence of the subsistence fund with respect to an individual, John, can be widened to include many individuals that trade with each other. John, who produces apples, can now secure meat and clothing from other individuals. This means that the subsistence fund is now comprises of a greater variety of final goods ready for human consumption. According to Böhm-Bawerk:

The entire wealth of the economical community serves as a subsistence fund, or advances fund, and, from this, society draws its subsistence during the period of production customary in the community.[3]

Note that the improvement of the infrastructure enables the strengthening in the economic growth. The improvement in the infrastructure in turn can take place because of the increase in the subsistence fund. Hence, anything that weakens the subsistence fund undermines the prospects for economic growth.

The Subsistence Fund and Money

Various producers who have exchanged their produce for money can now exchange their money for various consumer goods, i.e., they can access the subsistence fund whenever they deem this necessary. When an individual exchanges his money for goods, all that we have here is an act of exchange and not an act of payment—money is just the medium of exchange.

Payment is always done by means of various goods. For instance, a baker pays for shoes by means of the bread he produced, while the shoemaker pays for the bread by means of the shoes he made. (Both shoes and bread are part of the subsistence fund as they are final consumer goods). When the baker exchanges his money for shoes, he has already paid for the shoes, so to speak, with the bread that he produced prior to this exchange.

Intermediate Goods

What about a producer of an intermediate good, like a producer of a special tool—what is his contribution to the subsistence fund? An individual who exchanges his money for the tool will employ the tool in the production of final consumer goods or in the production of other tools and machinery that, in turn, will contribute to the production of final consumer goods sometime in the future.

The producer of the special tool does not directly supply final consumer goods. However, he does offer a means to secure these goods. Additionally, he also offers time.

According to Rothbard:

Crusoe without the axe is two hundred fifty hours away from his desired house; Crusoe with the axe is only two hundred hours away. If the logs of wood had been poled up ready-made on his arrival, he would be that much closer to his objective; and if the house were there to begin with, he would achieve his desire immediately, he would be further advanced toward his goal without the necessity of further restriction of consumption.

In addition, with the introduction of more advanced tools and machinery various new consumer goods can be produced, which prior to the making of these new tools and machinery were not available at all to individuals.

Now, what about things like various services, education and arts? Should we include them in the subsistence fund? We suggest that without the availability of consumer goods that sustain human beings various services and art cannot be generated. Once, people’s living standard increases all these things become affordable to human beings. Hence, anything that undermines the subsistence fund in fact undermines the ability to live like human beings as opposed to the existence in similarity to animals.

Monetary Expansion and Subsistence Fund 

When money is generated out of “thin air”, it leads to a weakening of the subsistence fund. What is the reason for this? The holder of the newly created money can use it to withdraw final consumer goods from the subsistence fund with no prior contribution to the fund. Hence, this act of consumption puts pressure on the fund. (The individual consumes goods without contributing to the subsistence fund).

We can infer from this that when money is generated out of “thin air” it diverts the means of sustenance away from wealth producers who have contributed to the subsistence fund towards the holders of the newly generated money. For a given subsistence fund this will imply that wealth producers will discover that the purchasing power of their money with respect to consumer goods has fallen since there are now less consumer goods left in the fund.

As the pace of money generation out of “thin air” intensifies, it puts more pressure on the subsistence fund. This in turn makes it much harder to implement various projects as far as the maintenance and the improvement of the infrastructure is concerned. Consequently the production flow of various final consumer goods weakens, which in turn makes it much harder to make provisions for savings. All this in turn further weakens the infrastructure and so undermines further the production flow of final consumer goods. Note that without the maintenance of the infrastructure its ability to generate final consumer goods is going to weaken.

The maintenance of the infrastructure requires the allocation of savings towards various individuals that maintain the infrastructure. If John will not add more sticks to his inventory at some point, the stick will break and the production of apples will halve. To have more sticks in his inventory John would have to allocate savings for this. We can thus conclude that contrary to the popular way of thinking, monetary growth cannot produce general expansion in economic activity.

On the contrary, by diverting the means of sustenance from wealth generating activities towards non-wealth-generating activities monetary expansion only weakens economic growth. Loose monetary and fiscal policies that aim at growing the economy are in fact achieving the exact opposite. As long as the growth rate of the subsistence fund stays positive, this can continue to sustain productive and nonproductive activities.

Trouble erupts, however, when, on account of loose monetary and fiscal policies, a structure of production emerges that tie up much more consumer goods than the amount it releases. (The consumption of final consumer goods exceeds the production of these goods). This excessive consumption relative to the production of consumer goods leads to a decline in the subsistence fund. This in turn weakens the support for individuals that are employed in the various stages of the production structure, resulting in the economy plunging into a slump.

Once the economy falls into a recession because of a decline in the subsistence fund, any government or central bank attempts to revive the economy is going to fail. Not only will these attempts fail to revive the economy, they will deplete the subsistence fund further, thereby prolonging the economic slump.

On this Mises wrote,

An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: The Santa Claus principle liquidates itself.[5]

Summary and Conclusions

Most individuals in the western world take the ample availability of goods and services for granted. Indeed, the complex structure of production gives the impression that what is required is simply the existence of demand and the rest will follow suit. The sophisticated structure of production, which generates seemingly unlimited goods, does not have a life of its own. In order that the production structure can continue to supply, the great quantity and the variety of goods, it requires a key ingredient, which is the subsistence fund. It is this fund, which not only maintains, but also enhances the production structure and thereby promotes people’s lives and well-being.

[1] Murray N. Rothbard Man Economy and State p 48

[2] Richard von Strigl, Capital & Production, Mises Institute, p 7

[3] Eugen von Böhm-Bawerk, The Positive Theory of Capital, Book 6, chapter 5, Macmillan and Co, 1891).

[4] Murray Rothbard, Man Economy and State, Nash Publishing, p.45.

[5] Human Action 3rd edition Contemporary Books p 858.

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