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In Part II and Part III we imagined that a number of foreigners who derive large annual incomes from assets in their country of origin arrive in Queensland. We assumed for simplicity that the foreigners liquidate none of their assets, that they spend all of their incomes in Queensland and that residents of Queensland own all of the wealth within the state. We then asked: will the foreigners’ expenditure of their income augment the wealth of the state’s residents? We have seen that if the foreigners spend all their income “unproductively,” i.e., on final rather than intermediate consumption, then no wealth is necessarily created and their presence will impart no general benefit upon the state’s residents. More generally and all else equal, in other words, increased consumption per se does nothing to make a society richer.
We now see, however, that if the foreigners save some portion of their incomes and invest these savings productively in Queensland, then they will indeed generate wealth; further, the greater the rate of saving and the more prolific the investment, the greater the fructification of wealth and the benefits to foreigners and residents alike. Hence our three classically-inspired (and to modern minds, heretical) conclusions: consumption (as it is conventionally defined) is not wealth and savings likely are; consumption destroys wealth and saving and investment likely produces wealth; and consumption never needs encouragement.
Yet Another Thought Experiment
Productively invested savings do much to benefit individual investors and the societies they inhabit. The classical economist Frédéric Bastiat, in his essay What Is Seen and What Is Not Seen, uses a story about two brothers to make this fundamental point (see also Henry Hazlitt, The Failure of the New Economics: An Analysis of the Keynesian Fallacies, Foundation for Economic Education, 1959, 1994, ISBN: 1572460016; and Economics in One Lesson, Laissez Faire Books Fiftieth Anniversary Edition, 1946, 1996, ISBN: 0930073207). Let us assume that each inherits a sum that yields $1,000,000 per year; that they are among the foreigners who sojourn to Queensland; that one brother, Mondor, is carefree spendthrift and that the other, Ariste, is a diligent saver. Both, it is important to emphasise, spend the annual income generated by their inheritance. The critical difference is the object of the expenditure: Mondor on goods and services for final (i.e., personal) consumption and Ariste on goods and services for intermediate consumption (i.e., investments).
Indeed, let us assume that Mondor is a lavish spender. He is regularly frequents and spends freely at night clubs; unaware of the local custom in Queensland, in which tipping is very much the exception rather than the rule, he gives generous pourboires; his house is pretentious, located in a fashionable neighbourhood and the site of much entertaining; he owns several late model motor cars; a race horse and a yacht; he is a frequent visitor to the racetrack and casino; he travels from one end of Queensland to another; he loads his wife with diamonds; and he gives expensive and useless presents to his many friends. It goes without saying that Mondor is a great favourite of his friends, neighbours, waiters and restaurant owners, jewelers, car dealers, estate agents and myriad others. They salute him as a public benefactor. It is obvious to all that his strenuous spending is “creating jobs” – and a good reputation for himself. To maintain himself and others in appropriate style he spends $1,500,000; each year, in other words, Mondor spends all of his income and a portion of his capital. Et alors? Surely saving is a sin and “dissaving” a virtue: the government’s rhetoric and policies, for example, tell him so. And in any case Mondor is simply compensating for the harm being done to local residents, or at least the benefits denied them, by the frugality, saving and investing of Ariste.
Ariste, alas, is much less popular. He lives in an average house in an average neighbourhood, is seldom seen at the jewelers or in the restaurants (and when he is there he spends carefully and modestly). He never frequents nightclubs and entertains friends and neighbours only occasionally and in a low-key manner. Because his status needs are low he lives rather humbly and frugally; accordingly, Ariste spends only about $100,000 per year and saves and invests the remainder. To the people who see only what is visible on the surface to the untrained observer (who, according to Bastiat, comprise the vast majority of people), Ariste provides only a small fraction of the employment that Mondor provides; and the other $900,000 per year, which the vast majority cannot see, may as well not exist.
Saving Is Spending
But what does Ariste actually do with the $900,000 per annum that he saves and invests? He does not bury it in his back garden or let it accumulate in his strongbox. He either deposits it in a bank or exchanges it for stocks, bonds and commercial real estate. If he deposits it in a bank, then the bank either lends it to a business or a homeowner or buys stocks, bonds or real estate. Ariste thus invests his money either directly or indirectly; either way, what is saved and invested is spent. Money that is invested is not used to buy goods and services for final consumption but rather to construct and utilise capital goods – the raw materials, factories, machines, etc. that, through a multi-stage structure of production, ultimately produce consumer goods and services. To invest $1 thus puts as much money into circulation – and gives as much employment – as the same amount of money spent directly on consumer goods. Saving, then, is another form of spending.
The critical difference between the two is that to consume a consumer good or service is to extinguish it and its value: once eaten, in other words, a Big Mac no longer has value because it no longer exists. Other consumer goods (motor cars, VCRs, etc.) are durable in the sense that they are consumed, and hence their value is extinguished, gradually. In sharp contrast, to “consume” iron ore is to transform it into rolled steel whose value is typically greater than the iron ore; and to “consume” steel is to transform it into machinery that produces cars and cars themselves. To invest, then, is to spend money on materials and machines that increase production and the value of what is produced. Accordingly, Ariste’s saving and expenditure of his annual income not only puts the same amount of money into circulation – it generates more and more enduring economic value than the expenditure of Mondor’s annual income. But Mondor’s spending can be easily seen, and it is necessary to look more carefully, and to think a moment, in order to recognise the indirect, delayed but nonetheless salutary consequences of Ariste’s prudent and productive saving.
...continued in Part V
 
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