Henry Hazlitt is well-known to Freeman readers as author, columnist, editor, lecturer, and practitioner of freedom. This article will appear as a chapter in a forthcoming book, The Conquest of Poverty, to be published by Arlington House.
The socialists and communists propose to cure poverty by seizing private property, particularly property in the means of production, and turning it over to be operated by the government.
What the advocates of all expropriation schemes fail to realize is that property in private hands used for the production of goods and services for the market is already for all practical purposes public wealth. It is serving the public just as much as—in fact, far more effectively than—if it were owned and operated by the government.
The private capitalist normally serves the public far better than the government could if it took over his property.
Suppose that a single rich man were to invest his capital in a railroad owned by himself alone. He could not use this merely to transport his own family and their personal goods. That would be ruinously wasteful. If he wished to make a profit on his investment, he would have to use his railroad to transport the public and their goods. He would have to devote his railroad to a public use.
And unlike a government agency, the private owner is obliged by self-preservation to try to avoid losses, which means that he is forced to run his railroad economically and efficiently. And also unlike a government agency, the private capitalist is nearly always obliged to face competition—which means to make the services he provides or the goods he sells superior or at least equal to those provided by his competitors. Therefore the private capitalist normally serves the public far better than the government could if it took over his property.
Looked at from the standpoint of the service they provide, the private railroads today are worth vastly more to the public than to their owners.
Though socialists chronically fail to understand it, there is nothing original in the theme just stated. It was hinted at in Adam Smith:
Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to the society.1
At another point Adam Smith was even more explicit:
Every prodigal appears to be a public enemy, and every frugal man a public benefactor…. The principle which prompts to save, is the desire of bettering our condition…. An augmentation of fortune is the means by which the greater part of men propose and wish to better their condition…. And the most likely way of augmenting their fortune, is to save and accumulate some part of what they desire…. [The funds they accumulate] are destined for the maintenance of productive…. The productive powers of the same number of laborers cannot be increased, but in consequence either of some addition and improvement to those machines and instruments which facilitate and abridge labor; or of a more proper division and distribution of employment. In either case an additional capital is almost always required.2
In the history of economic thought, however, it is astonishing how much this truth was neglected or forgotten, even by some of Smith’s most eminent successors. But the theorem has been revived, and some of its corollaries more explicitly examined, by several writers in the present century.
How Henry Ford Profitably Served the Public
One of them was George E. Roberts, director of the U.S. Mint under three Presidents, who was responsible for the Monthly Economic Letter of the National City Bank of New York from 1914 until 1940.
An example often cited by Roberts was Henry Ford and his automobile plant. Roberts pointed out in the July letter of 1918 that the portion of the profits of Henry Ford’s automobile business that he had invested in the development and manufacture of a farm tractor was not devoted to Ford’s private wants; nor was that portion which he invested in furnaces for making steel; nor that portion invested in workingmen’s houses.
If Henry Ford had exceptional talent for the direction of large productive enterprises the public had no reason to regret that he had an income of $50,000,000 a year with which to enlarge his operations. If that income came to him because he had a genius for industrial management, the results to the public were probably larger than they would have been if the $50,000,000 had been arbitrarily distributed at 50 cents per head to all the [then, 1918] population of the country.
In brief, only that portion of his income which the owner spends upon himself and his dependents is devoted to him or to them. All the rest is devoted to the public as completely as though the title of ownership was in the state. The individual may toil, study, contrive, and save, but all that he saves inures to others.
But the Ford Motor Company, from the profits of which the original owner drew so little for his own personal needs, is not a unique example in American business. Perhaps the greater part of private profits are today reinvested in industry to pay for increased production and service for the public.
Profits After Taxes Average 4 Percent of Sales
Let us see what happened, for example, to all the corporate profits in the United States in 1968, fifty years after George Roberts was writing about the Ford Company. These aggregate net profits amounted before taxes to a total of $88.7 billion (or one-eighth of the total national income in that year of $712.7 billion).
Out of these profits the corporations had to pay 46 percent, or $40.6 billion, to the government in taxes. The public, of course, got directly whatever benefit these provided. Corporate profits after taxes then amounted to $48.2 billion, or less than 7 percent of the national income.
For every dollar that the corporations took in from sales, they paid out 96 cents.
These profits after taxes, moreover, averaged only 4 cents for every dollar of sales. This meant that for every dollar that the corporations took in from sales, they paid out 96 cents—partly for taxes, but mainly for wages and for supplies from others.
But by no means all of the $48.2 billion earned after taxes went to the stockholders of the corporations in dividends. More than half—$24.9 billion—was retained or reinvested in the business. Only $23.3 billion went to the stockholders in dividends.
There is nothing untypical in these 1968 corporate reinvestment figures. In every one of the six years preceding 1968 the amount of funds retained for reinvestment exceeded the total amount paid out in dividends.
Moreover, even the $25 billion figure understates corporate reinvestment in 1968. For in that year the corporations suffered $46.5 billion depreciation on their old plant and equipment. Nearly all of this was reinvested in repairs to old equipment or to complete replacement. The $24.9 billion represented reinvestment of profits in additional or greatly improved equipment.
And even the $23.3 billion that finally went to stockholders was not all retained by them to be spent on their personal consumption. A great deal of it was reinvested in new enterprises. The amount is not precisely ascertainable; but the U. S. Department of Commerce estimates that total personal savings in 1968 exceeded $40 billion.
Thus because of both corporate and personal saving, an ever-increasing supply is produced of finished goods and services to be shared by the American masses.
In a modern economy, in brief, those who save and invest can hardly help but serve the public. As Mises has put it:
In the market society the proprietors of capital and land can enjoy their property only by employing it for the satisfaction of other people’s wants. They must serve the consumers in order to have any advantage from what is their own. The very fact that they own means of production forces them to submit to the wishes of the public. Ownership is an asset only for those who know how to employ it in the best possible way for the benefit of the consumers. It is a social function.3
It follows from this that the rich can do the most good for the poor if they refrain from ostentation and extravagance, and if instead they save and invest their savings in industries producing goods for the masses.
F.A. Harper has gone so far as to write:
Both fact and logic seem to me to support the view that savings invested in privately owned economic tools of production amount to an act of charity. And further, I believe it to be—as a type—the greatest economic charity of all.4
Professor Harper supports this view by quoting, among others, from Samuel Johnson, who once said: "You are much surer that you are doing good when you pay money to those who work, as a recompense of their labor, than when you give money merely in charity."5
So, saving and sound investment are by far the most important means by which the rich can confer benefits on the poor.
Saving and Investment
This theme has found expression in this century by a deplorably small number of writers. One of the most persuasive was Hartley Withers, a former editor of the famous London Economist, who published an ingratiating little book in 1914, a few weeks before the outbreak of the First World War, called Poverty and Waste.6 The contention of his book is that when a wealthy man spends money on luxuries he causes the production of luxuries and so diverts capital, energy, and labor from the production of necessaries, and so makes necessaries scarce and dear for the poor. Withers does not ask him
… to give his money away, for he would probably do more harm than good thereby, unless he did it very carefully and skilfully; but only to invest part of what he now spends on luxuries so that more capital may be available for the output of necessaries. So that by the simultaneous process of increasing the supply of capital and diminishing the demand for luxuries the wages of the poor may be increased and the supply of their needs may be cheapened; and he himself may feel more comfortable in the enjoyment of his income.7
Yet in spite of the authority of the classical economists and the inherent strength of the arguments for saving and investment, the gospel of spending has an even older history. One of the chief tenets of the "new economics" of our time is that saving is not only ridiculous but the chief cause of depressions and unemployment.
Adam Smith’s arguments for saving and investment were at least partly a refutation of some of the mercantilist doctrines thriving in the century before he wrote. Professor Eli Heckscher, in his Mercantilism (2 vol., 1935), quotes a number of examples of what he calls
the deep-rooted belief in the utility of luxury and the evil of thrift. Thrift, in fact, was regarded as the cause of unemployment, and for two reasons: in the first place, because real income was believed to diminish by the amount of money which did not enter into exchange, and secondly, because saving was believed to withdraw money from circulation.8
An example of how persistent these fallacies were, long after Adam Smith’s refutation, is found in the words that the sailor-turned-novelist, Captain Marryat, put into the mouth of his hero, Mr. Midshipman Easy, in his novel by that name published in 1836:
The luxury, the pampered state, the idleness—if you please, the wickedness—of the rich, all contribute to the support, the comfort, and the employment of the poor. You may behold extravagance—it is a vice; but that very extravagance circulates money, and the vice of one contributes to the happiness of many. The only vice which is not redeemed by producing commensurate good, is avarice.
Mr. Midshipman Easy is supposed to have learned this wisdom in the navy, but it is almost an exact summary of the doctrine preached in Bernard Mandeville’s Fable of the Bees in 1714.
Now though this doctrine is false in its attack on thrift, there is an important germ of truth in it. The rich can hardly prevent themselves from helping the poor to some extent, almost regardless of how they spend or save their money. So far from the wealth of the rich being the cause of the poverty of the poor, as the immemorial popular fallacy has it, the poor are made less poor by their economic relations with the rich. Even if the rich spend their money foolishly and wastefully, they give employment to the poor as servants, as suppliers, even as panders to their vices. But what is too often forgotten is that if the rich saved and invested their money they would not only give employment to just as many people producing capital goods, but that as a result of the reduced costs of production and the increased supply of consumer goods which this investment brought about, the real wages of the workers and the supply of goods and services available to them would greatly increase.
The result is increased envy of, and sullenness toward, those who are making them better off.
What is also forgotten by the defenders of luxury spending is that, though it improves the condition of the poor who cater to it, it also increases their dissatisfaction, unrest, and resentment. The result is increased envy of, and sullenness toward, those who are making them better off.
The first eminent economist who attempted to refute Adam Smith’s proposition that "every prodigal appears to be a public enemy, and every frugal man a public benefactor" was Thomas R. Malthus.
Malthus’s objections were partly well taken and partly fallacious. I have examined them rather fully in another place;9 and I shall content myself here with quoting a few lines from the answer that a greater economist than Malthus, David Ricardo, made at the time (circa 1814-21):
Mr. Malthus never appears to remember that to save is to spend, as surely as what he exclusively calls spending…. I deny that the wants of consumers generally are diminished by parsimony—they are transferred with the power to consume to another set of consumers.10
John Maynard Keynes
We have yet to discuss the views of the most influential opponent of saving in our time—John Maynard Keynes.
It is widely believed, especially by his disciples, that Lord Keynes did not condemn saving until, in a sudden vision on his road to Damascus, the truth flashed upon him and he published it in The General Theory of Employment, Interest, and Money in 1936. All this is apocryphal. Keynes disparaged saving almost from the beginning of his career. He was warning his countrymen in a broadcast address in January, 1931, that "whenever you save five shillings, you put a man out of work for a day." And long before that, in his Economic Consequences of the Peace, published in 1920, he was writing passages like this:
The railways of the world which [the 19th century] built as a monument to posterity, were, not less than the Pyramids of Egypt, the work of labor which was not free to consume in immediate enjoyment the full equivalent of its efforts.
Thus this remarkable system depended for its growth on a double bluff or deception. On the one hand the laboring classes accepted from ignorance or powerlessness, or were compelled, persuaded, or cajoled by custom, convention, authority, and the well-established order of Society into accepting, a situation in which they could call their own very little of the cake that they and Nature and the capitalists were cooperating to produce. And on the other hand the capitalist classes were allowed to call the best part of the cake theirs and were theoretically free to consume it, on the tacit underlying condition that they consumed very little of it in practice. The duty of "saving" became nine-tenths of virtue and the growth of the cake the object of true religion. There grew round the non-consumption of the cake all those instincts of puritanism which in other ages has withdrawn itself from the world and has neglected the arts of production as well as those of enjoyment. And so the cake increased; but to what end was not clearly contemplated. Individuals would be exhorted not so much to abstain as to defer, and to cultivate the pleasures of security and anticipation. Saving was for old age or for your children; but this was only in theory—the virtue of the cake was that it was never to be consumed, neither by you nor by your children after you. (pp. 19-20.)
This passage illustrates the irresponsible flippancy that runs through so much of Keynes’s work. It was clearly written tongue-in-cheek. In the very next sentences Keynes made a left-handed retraction: "In writing thus I do not necessarily disparage the practices of that generation. In the unconscious recesses of its being Society knew what it was about," etc.
Yet he let his derision stand to do its harm.
Both Keynes and his disciples have so confused themselves and others with their mockery that it is worth making the matter plain.
If we accepted Keynes’s original passage as sincerely written, we would have to point out in reply: (1) The railways of the world cannot be seriously compared with the pyramids of Egypt, because the railways enormously improved the production, transportation, and availability of goods and services for the masses. (2) There was no bluff and no deception. The workers who built the railroads were perfectly "free" to consume in immediate enjoyment the full equivalent of their efforts. It was the capitalist classes that did nearly all the saving, not the workers. (3) Even the capitalist classes did consume most of their slice of the cake; they were simply wise enough to refrain from consuming all of it in the same year as they baked it.
This point is so fundamental, and both Keynes and his disciples have so confused themselves and others with their mockery and intellectual somersaults, that it is worth making the matter plain by constructing an illustrative table.
Results in Ruritania: A Larger "Cake"
Let us assume that in Ruritania, as a result of net annual saving and investment of 10 percent of output, there is over the long run an average increase in real production of 3 percent a year. Then the picture of economic growth we get over a ten-year period runs like this in terms of index numbers:
(These results do not differ too widely from what has been happening in recent years in the United States.)
What this table illustrates is that total production in Ruritania increases each year because of the net saving (and consequent investment), and would not increase without it. The saving is used year after year to increase the quantity and improve the quality of existing machinery or other capital equipment, and so to increase the output of both consumption and capital goods.
In a Keynesian world, in which saving was a sin, production would go lower and lower, and the world would get poorer and poorer.
Each year there is a larger and larger "cake." Each year, it is true, not all of the currently produced cake is consumed. But there is no irrational or cumulative consumer restraint. For each year a larger and larger cake is in fact consumed; until even at the end of five years (in our illustration), the annual consumers’ cake alone is equal to the combined producers’ and consumers’ cakes of the first year. Moreover, the capital equipment, the ability to produce goods, is now 12 percent greater than in the first year. And by the tenth year the ability to produce goods is 30 percent greater than in the first year; the total cake produced is 30 percent greater than in the first year, and the consumers’ cake alone is more than 17 percent greater than the combined consumers’ and producers’ cakes in the first year.
No Allowances for Depreciation
There is a further point to be taken into account. Our table is built on the assumption that there has been a net annual saving and investment of 10 percent a year; but in order to achieve this Ruritania will probably have to have a gross annual saving and investment of, say, twice as much, or 20 percent, to cover the repairs, depreciation and deterioration taking place every year in housing, roads, trucks, factories, equipment. This is a consideration for which no room can be found in Keynes’s simplistic and mocking cake analogy. The same kind of reasoning which would make it seem silly to save for new capital would also make it seem silly to save enough even to replace old capital.
New capital is formed by production combined with saving.
In a Keynesian world, in which saving was a sin, production would go lower and lower, and the world would get poorer and poorer.
In the illustrative table I have by implication assumed the long-run equality of saving and investment. Keynes himself shifted his concepts and definitions of both saving and investment repeatedly. In his General Theory the discussion of their relation is hopelessly confused. At one point (p. 74) he tells us that saving and investment are "necessarily equal" and "merely different aspects of the same thing." At another point (p. 21) he is telling us that they are "two essentially different activities" without even a "nexus."
Produce, Save, Invest
Let us, putting all this aside, try to look at the matter both simply and realistically. Let us define saving as an excess of production over consumption; and let us define investment as the employment of this unconsumed excess to create additional means of production. Then, though saving and investment are not always necessarily equal, over the long run they tend to equality.
New capital is formed by production combined with saving. Before there can be a given amount of investment, there must be a preceding equal amount of saving. Saving is the first half of the action necessary for more investment.
To complete the act of forming capital it is of course necessary to complement the negative factor of saving with the positive factor of devoting the thing saved to a productive service…. [But] saving is an indispensable condition precedent of the formation of capital.¹¹
Keynes constantly deplored saving while praising investment, persistently forgetting that the second was impossible without the first.
Of course it is most desirable economically that whatever is saved should also be invested, and in addition invested prudently and wisely. But in the modern world, investment follows or accompanies saving almost automatically. Few people in the Western world today keep their money under the floor boards. Even the poorer savers put their money out at interest in savings banks; and those banks act as intermediaries to take care of the more direct forms of investment. Even if a man keeps a relatively large sum in an inactive checking deposit, the bank in which he keeps it, trying always to maximize its profits or to minimize losses, seeks to keep itself "fully loaned up"—that is, with close to the minimum necessary cash reserves. If there is insufficient demand at the time for commercial loans, the bank will buy Treasury bills or notes. The result in the United States, for example, is that a bank in New York or Chicago would normally lend out five-sixths of the "hoarder’s" deposit; and a "country bank" would lend out even more of it.
It may be instructive to begin by distinguishing between three kinds of (or motives for) saving.
Of course, to repeat, a saver can do the most economic good, both for himself and his community, if he invests most of his savings, and invests them prudently and wisely. But—contrary to the theories of the mercantilists and the Keynesians—even if he "hoards" his savings he may often benefit both himself and the community and at least under normal conditions do no harm.
To understand more clearly why this is so it may be instructive to begin by distinguishing between three kinds of (or motives for) saving, and three groups of savers—roughly the poor, the middle class, and the wealthy.
Let us call the most necessary kind, which even the poorest must practice, "rent-day saving." Men buy and pay for things over different time periods. They buy and pay for food, for the most part, daily. They pay rent weekly or monthly. They buy major articles of clothing once or twice a year. A man who earns $10 a day cannot afford to spend $10 a day on food and drink. He can spend on them, say, not more than $6 a day, and must put aside $4 a day from which to pay out part at the end of the month for rent, light, and heat, and another part for a winter overcoat at the end of six months, and so on. This is the kind of saving necessary to ensure one’s ability to spend throughout the year. "Rent-day saving" can symbolize all the saving necessary to pay for regularly recurrent and unavoidable living expenses. Obviously this kind of saving, sustained only for weeks or a season, is not cumulative and can in no circumstances be held responsible for business depressions. It is utter irresponsibility to ridicule it.
Rainy-Day Saving Can’t Cause Depression
The next kind of saving, which applies especially to the middle classes, or moderately well off, is what we may call "rainy-day saving." This is saving against such possible contingencies as loss of a job, illness in the family, death of the breadwinner, or the like.
It is this "rainy-day saving" that the Keynesians most deplore, and from which they fear the direst consequences. Yet even in extreme cases it does not, except in very special cyclical circumstances, tend to bring about any depression or economic slowdown. Savings, even when they are not invested in production goods, are merely deferred or postponed spending. Let us consider, for example, a society consisting entirely of "hoarders" and "misers." They are hoarders and misers in this sense: that they all assume they are going to live till 70 but will be forced to retire at 60; and they want to have as much to spend in each of their last ten years as in their 40 working years from 20 to 60. This means that each family will save one-fifth of its annual income over 40 years in order to have the same amount to spend in each of its final ten years.
We are deliberately assuming the extreme case, so let us assume that the money saved is not invested in a business or in stocks or bonds, is not even put in a savings bank, earns no interest, but is simply "hoarded."
This of course would permit no economic improvement whatever, but if it were the regular permanent way of life in that community, at least it would not lead to a depression. The people who refrained from buying a certain amount of consumers’ goods and services would not be bidding up their prices; they would simply be leaving them for others to buy. If this saving for old age were the regular and expected way of life, and not some sudden unanticipated mania for saving, the manufacturers of consumer goods would not have produced an oversupply to be left on their hands; the older people in their seventh decade would in fact be spending more than similarly aged people in a "spending" society, and the unspent savings of those who died would revert to the spending stream. Over a long period, year by year, there would be just as much spent as in a "spending" society.
Let us remember that money saved, in an evenly-rotating economy, where there is neither monetary inflation nor deflation, does not go out of existence. Savings, even when they are not invested in production goods, are merely deferred or postponed spending. The money stays somewhere and is always finally spent. In the long run, in a society with a relatively stable ratio between hoarders and spenders, savings are constantly coming back into the spending stream, through old-age spending or through deaths, keeping the stream at an even flow.
Keynes’s allegory of the extent of supposed 19th-century thrift was surely his own hallucination.
What we are trying to understand is merely the effect of saving per se, and not of sudden and unanticipated changes in spending and saving. Therefore we are abstracting from the effects produced by unexpected changes in spending and saving or changes in the stock of money. If even a heavy amount of saving were the regular way of life in a community, the relative production and prices of consumers’ and producers’ goods would already be adjusted to this. Of course, if a depression sets in from some other cause, and the prices of securities and of goods begin to fall, and people suddenly fear the loss of their jobs, or a further fall in prices, this may lead to a massive and unanticipated increase in saving (or more exactly in nonspending) and this may of course intensify a depression already begun from other causes. But depressions cannot be blamed on regular, predictable, anticipated saving.
Some readers may contend that I have not yet imagined the most extreme case of saving—a society, say, all the members of which perpetually save more than half as much as they earn, and keep saving, not for old age, or for any reasonable contingency, but simply because of a "religion" of saving. In brief, these would be the cake nonconsumers of Keynes’s satire. But such an imaginary society involves a contradiction of assumptions. If the members of that society intended always to live at their existing modest or even mean level, why would they keep exerting themselves to produce more than they ever expected to consume? That would be pathologic to the point of insanity. Keynes’s allegory of the extent of supposed 19th-century thrift was surely his own hallucination.
Capitalistic Saving for Investment in Industry
We come finally to the third type of saving—what we may call "capitalistic" saving. This is saving that is put aside for investment in industry—either directly, or indirectly in the form of savings bank deposits. It is saving that yields interest or profits. The saver hopes, in his old age or even earlier, to live on the income yielded by his investments rather than by consuming his saved capital.
This type of "capitalistic" saving was until recently confined to the very rich. Indeed, even the very rich were not able to take advantage of this type of saving until the modern development of banks and corporations. Contrary to age-old prejudices, the wealth of the rich is not the cause of the poverty of the poor, but helps to alleviate that poverty. As late as the beginning of the 18th century we hear of London merchants on their retirement taking a chest of gold coin with them to the country with the intention of gradually drawing on that hoard for the rest of their lives.¹² Today the greater part even of the American middle classes, however, enjoy the advantage of capitalistic saving.
To sum up. Contrary to age-old prejudices, the wealth of the rich is not the cause of the poverty of the poor, but helps to alleviate that poverty. No matter whether it is their intention or not, almost anything that the rich can legally do tends to help the poor. The spending of the rich gives employment to the poor. But the saving of the rich, and their investment of these savings in the means of production, gives just as much employment, and in addition makes that employment constantly more productive and more highly paid, while it also constantly increases and cheapens the production of necessities and amenities for the masses.
The rich should of course be directly charitable in the conventional sense, to people who because of illness, disability, or other misfortune cannot take employment or earn enough. Conventional forms of private charity should constantly be extended. But the most effective charity on the part of the rich is to live simply, to avoid extravagance and ostentatious display, and to save and invest so as to provide more people with increasingly productive jobs, and to provide the masses with an ever-greater abundance of the necessities and amenities of life.
1Wealth of Nations (1776), Bk. IV, Ch. II. Labor
2 Ibid., Bk. II, Ch. III.
3Ludwig von Mises, Human Action (Third Revised Edition; Chicago: Henry Regnery Co., 1966), p. 648.
4"The Greatest Economic Charity." Essay in symposium On Freedom and Free Enterprise, Mary Sennholz, ed. Van Nostrand, 1956), p. 99.
5 James Boswell, The Life of Samuel Johnson (Boston: Charles E. Lauriat Co., 1925). Vol. II, p. 636.
6(London: Smith, Elder, 1914; Second, Revised Edition, John Murray, 1931.)
7Poverty and Waste, p. 139.
8Vol. ii, p. 208.
9The Failure of the "New Economics" (Van Nostrand, 1959), pp. 40-43 and 355-362.
10Notes on Malthus (Sraffa edition), p. 449 and p. 309.
11 Eugen von Böhm-Bawerk, Positive Theory of Capital, 1891 (South Holland, Ill.: Libertarian Press, 1959), pp. 104, 118.
12F.A. Hayek, Profits, Interest and Investment (London: George Routledge, 1939), pp. 162-163. See also the numerous cases mentioned in G. M. Trevelyan’s English Social History (David McCay, 1942).