All Commentary
Wednesday, May 1, 1974

The Role of Savings

Mr. Summers is a member of the staff of the Foundation for Economic Education.

One of the least appreciated aspects of the private enterprise system is the role of savings in increasing the wealth of all the people. That the savings of some can increase the wealth of all may seem, at first glance, paradoxical, so let us consider for a moment just what happens when an individual — call him Joe — forgoes a little spending to put a sum in the bank.

Some people say: “The money that Joe has saved is money that won’t be spent. The decrease in Joe’s consumption can only mean a commensurate decrease in production and a resulting rise in unemployment. Saving should really be discouraged.”

Saving is a form of spending!

Joe’s money doesn’t just sit in the bank; the bank must lend it to someone in order to earn money to pay Joe interest. This lending is not only a form of spending, it is, in fact, the only kind of spending that actually increases wealth: investment.

What happens when money is invested? Say a corporation goes to Joe’s bank and borrows money to build a factory. The corporation then spends Joe’s money on building materials, machines, tools, and labor. The money that Joe has saved winds up being spent just the same as if he had spent it himself. There is no decrease in production and no rise in unemployment. It fact, as we shall see, there is an increase in production and a decline in unemployment!

Soon the factory is complete. The corporation then proceeds to hire workers. Joe’s savings have increased employment!

How does the corporation hire workers? By offering better conditions of employment than their competitors. Perhaps the most important condition — as far as workers are concerned — is the level of wages. In all probability, the workers in the new factory have been lured by higher salaries. Joe’s savings, whether he realizes it or not, have increased the wealth of workers in a factory he probably has never seen.

“You said that savings increase the wealth of all the people. What about the 210 million Americans who don’t work in Joe’s factory?”

Competitive Bidding

Consider first the workers in competing factories. If these factories don’t want to lose their workers to new factories, they had better raise their wages. Joe’s savings have increased salaries throughout an entire industry!

As for workers in other fields, we should remember that most of them are potential factory workers. If you want to keep your best farm hand from going off to work in Joe’s industry or taking a job that has been vacated by someone else who went off to work in Joe’s industry, you had better give him a raise. Competition among employers means that Joe’s savings, and the savings of millions of other Americans, raise the wages of all workers.

“That is still not everybody! How about people who don’t work?”

Every man, woman, and child —worker and nonworker — is a consumer. The end of economic activity — saving, factory building, working, and all the rest — is consumption. We should always keep this end in mind. The higher wages we have talked about would prove meaningless if they didn’t result in increased consumption.

Joe’s savings benefit everyone because the factory, machines, and tools they helped build are designed to produce goods that consumers will prefer to those already being offered on the market. The corporation that borrowed money from Joe’s bank took a financial risk because they think that they can satisfy consumers better than their competitors. In other words, they hope to give the consumer more for his money. If they fail, then the loss is theirs. If they succeed, then consumers consume more of what they want and thus enjoy a higher standard of living. The consumer — each and every one of us — is the final judge and ultimate winner.

“Savings seem to be pretty good after all. What should be done to encourage more saving?”

Instead of doing things to encourage saving, we should undo things that discourage it. In particular, the law itself is probably the greatest hindrance potential savers face. Let us make a brief survey of some of the ways in which the law discourages saving. To begin with, people can’t save money they no longer have. Every dollar that goes in taxes is a dollar that won’t be saved. Add up all the taxes that Joe pays, and he may find himself withdrawing from, rather than adding to, his bank account.

Tax Disincentives

In addition to the general level of taxation, several specific taxes are especially discouraging to savers. Corporate profits taxes, capital gains taxes, and taxes on dividends and bank account interest hit the saver particularly hard and must be taken into account by every potential saver.

High as taxes are, government spending is even higher. The difference, of course, is “made up” by running fiat money off the government printing presses — inflation. And inflation, combined with other ramifications of over-extended government, is enough to give even the most devoted saver cause to rethink his frugal habits.

The saver sees inflation galloping along faster than legal limits on interest rates. Even though he actually has lost money, in terms of purchasing power, he finds himself forced to pay taxes on his “earnings.”

The saver sees inflation increasing the paper value of his capital holdings. When he sells his holdings he must pay capital gains taxes — even though his “capital gains,” in terms of real wealth, actually may have been capital losses. The saver sees inflation increasing the replacement costs of capital equipment — machines, spare parts, tools — while depreciation allowances are determined by original costs. He finds that depreciation allowances have become inadequate to pay for new equipment to replace the old.

The saver sees inflation increasing the paper profits of his corporation. In particular, inventory “profits” — the difference between the cost of producing an item and the cost of later replacing it in inventory after it has been sold —are a direct result of inflation. Were all these inventory “profits” available for investment in new inventory, the corporation could at least hold its own. However, almost half these “profits,” on the average, wind up as corporate profits taxes. Thus, the saver may find his corporation losing money and paying profits taxes at the same time.

Inflation itself, even without being combined with various governmental controls and taxes, is discouraging to potential savers. With prices rising, people are encouraged to make purchases before prices go any higher, rather than to save for future purchases.

This brief survey of ways in which the law discourages saving is, of course, by no means complete. However, I would like to conclude with one factor that can never be measured, but which is nonetheless very real. This is the factor of uncertainty. In recent years, the United States government has grown so interventionistic that every few months the president is announcing “strong new” economic measures. Who knows what is next? Already we hear congressmen calling for a virtual nationalization of oil companies.

Who is going to invest under such circumstances? To complete the destruction of the American economy, the government does not have to expropriate the means of production. It merely has to make conditions so onerous and so frightful that no one will dare invest in private enterprise.

A free market, and the belief that the market will continue to be free, is all the encouragement savers ever need.