Savings and Economic Growth

Maybe someday
Saved by zero
I'll be more together
Stretched by fewer
--The Fixx

Nice primer on why it is saving, not consumption, that drives economic growth. The logic is grounded in basic axioms. The natural state of the world is one of scarcity. Alleviating scarcity requires production--i.e., the combination of labor with other factors of production.

If all production is consumed, then standard of living is maximized in the here and now. However, consuming all production leaves nothing for growth in the future. The only way production can increase in the future is to set aside some of today's production in the form of savings, and then apply those savings toward projects that offer promise for improving future productivity (defined as the amount of output obtained per scarce unit of input).

Think of it this way. Suppose you wish to cure cancer. Curing cancer requires research. Research requires researchers. People engaged in research must eat, cloth themselves, have a place to live, etc. Where do the resources come from to support those researchers working hard to cure cancer?

The answer is that they can only come from production that others have set aside. If all production is consumed, then nothing is left over to support cancer research.

The same holds true for any productivity improvement project. Production set aside becomes savings. Savings becomes capital. Capital drives productivity improvement.

The basic proposition is this: the higher the savings rates, the greater the future economic growth.

Policymakers currently believe that consumption drives economic growth. They are pulling out all stops to encourage borrowing (i.e., consuming more than one's income by borrowing from others) and spending (consumption).

Meanwhile, policies that suppress returns on savings below the natural rate of interest discourage people from setting income aside.

What we are engaging in is capital consumption. When capital is consumed to boost standard of living in the here and now, we kill the goose that lays golden eggs for future prosperity.