February 23, 2018

Fiscal policy and the Humpty Dumpty Fallacy

Comment on ProGrowthLiberal on ‘A Kennedy-Reagan-Trump Fiscal Policy?’


Economists think since the Classicals that saving and investment are two sides of the same coin. And since investment is good for growth, saving here and now makes us richer in the future. According to Adam Smith, the saver/capitalist is the true hero of wealth creation.

Brad DeLong updates the story as follows: “The economy’s savings-investment effort rate, s, has two parts: private and government saving: s=sp+sgs=sp+sg. The private savings rate spsp is very hard to move by changes in economic policy. Policy changes that raise rates of return on capital ― interest and profit rates ― both make it more profitable to save and invest more but also make us richer in the future, and so diminish the need to save and invest more.”

Note that the saving-investment link is hardwired in the economist’s brain. Keynes put it thus: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (GT, p. 63)

With regard to the currently increasing government deficit, this makes the representative economist wonder: “We have been asking the same question since 1981 ― how can anyone argue that a fall in national savings is good for long-term growth? We still have not received a coherent answer.”

The coherent answer is that economists get the relationship between saving and investment wrong since Adam Smith.

To make matters short, the axiomatically correct relationships are given here without further explanation.#1 It holds, with Qmonetary profit/loss, Sm monetary saving/dissaving, I investment expenditures, G government spending, T taxes:
(i) Qm≡−Sm in the elementary production-consumption economy,
(ii) Qm≡I−Sm in the elementary investment economy,
(iii) Qm≡(G−T)+I−Sm in the investment economy with government deficit/surplus.

The point to grasp is that there is NO such thing as an equality/identity/equilibrium of household/government sector saving and business sector investment, and NEVER was, and NEVER will be.

According to (i) household sector saving produces a loss in the business sector, and according to (iii) a government sector deficit produces a profit in the business sector. Investment I is a variable that moves INDEPENDENTLY from both private and public saving/dissaving.

Where, then, does the notorious identity/equality of saving/investment come from?

Let us take equation (ii) and play a semantic shell game. Enter Humpty Dumpty who introduces a redundant definition by saying that profit may be called “saving of the business sector” and that this “saving” can be added up with saving of the household sector to “total saving” Σ thus
(a) Σ≡Qm+Sm and now (ii) is rewritten
(b) Qm+Sm≡I and then
(c) Σ≡I that is, “total saving” is “by definition” identical to investment or in the usual sloppy parlance “saving equals investment” which obviously contradicts (ii) and ― strangely enough ― makes profit invisible.

This methodological idiocy is at the bottom of all I=S/IS-LM models and Post Keynesian economics in general.#2

So, the coherent answer to the question of why a fall in national savings could be good for long-term growth is that it boosts profit. The representative economist never got this because the profit theory is false since Smith/Ricardo.#3 This means that economic policy guidance in general, and fiscal policy in particular, NEVER had sound scientific foundations.

Egmont Kakarot-Handtke

#1 For details of the big picture see cross-references Refutation of I=S
#2 Why Post Keynesianism Is Not Yet a Science
#3 Ricardo, too, got profit theory wrong

Related 'I is never equal S and even Nick Rowe will eventually grasp it' and 'Getting out of IS-LM = Getting out of despair' and 'Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It'.