Does Lower Consumption Mean Lower Growth?

No savings

No Savings


I find it quite remarkable that after all these years Karl Marx is still held in high esteem even though he was refuted, and correctly so by Ludwig von Mises and Fredrick Hayek many a decade ago. There seems to be a general misunderstanding that saving leads to lower consumption, and lower consumption causes economic slow down. Has anyone bothered to check whether it is in fact true?

If too much of the income created by capitalism’s capacity to increase production flows to people who are already rich and likely to save rather than spend, then crises of under-consumption become almost inevitable, as described by Marx in Das Kapital and analyzed more rigorously by John Maynard Keynes in the 1930s. The only way to avert such crises is to create financial systems that recycle ex­­cess incomes from rich savers to poorer consumers via a build-up of debt.

The under consumption theory and the macro economic analysis is the result mainly of John Maynard Keynes although it was and is wholly false. It’s been the cause of so many faulty interventions by the government, but more importantly, it was adopted ‘because’ it gave government more control over the businesses. Giving the government the power to give monopoly powers to a select few in the name of control and helping the poor.

So what happens when the consumption drops and people start saving more? Where does that saving go? Does it disappear in thin air? Do the people hoard the money under a carpet? Or do they actually save it in a bank? Not everyone does the same thing but a lot of the funds end up in banks as savings. With people saving more and consuming less, the retail stores and other consumption goods experience a contraction. Generally the economist believe this should not happen and start their intervention at this point.

Now the bank has the savings, and the bank pays and interest on it. The bank, to pay the interest to the saver has to make that money up from somewhere using these funds. And how does the bank do that? Yes, you’re right, the bank lends these funds to businesses, that it deems not so risky. These businesses use these funds to ‘expand’ their business. That means they build a new warehouse or start a new software division, or expand to build a new signalling tower. This expansion actually now employs people to do the work. There is higher unemployment in the retail industry but greater growth and demand for workers in the new and growing sectors. This is the part Keynesians miss. Economy is not just one homogeneous good but rather many kinds of goods, and sectors, some expanding and some contracting at the same time.

Yes, the rich can’t consume too much, but their savings and investments create untold new opportunities. Savings are the primary reason for real growth as opposed to forced consumption. Pakistan has lower savings, leading to lower capital creation. It is not the case that the lack of consumption from the rich leads to a recession. If everyone started just consuming instead of saving and investing, sooner or later the economy will start to sputter as no new capital will have been created, leading to economy starting to lag behind other economies investing in newer and better capital goods.

If people don’t save, how are they going to take care of themselves in old age? They’ll automatically start forcing government due to their voting power to take care of them at the expense of the younger generation.

The under consumption theory is false simply because there are more than one good in the market. Some goods get consumed and demanded more than others instead of having one aggregate. The savings and investments let an economy build those tools that help in creating better and more advanced goods. These tools lead to a lot more output, leading to greater growth. This capital accumulation (physical producer goods) are the reason some countries prosper while others dwell in perpetual backwardness.


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