The Meaning of Saving and Investment Further Considered

1. Additional Defintion of Saving and Investment

Chapter 6 defined Saving and Investment to be equal in amount, as different aspects of the same thing to the society as a whole.

I and several contemporary writers have, however, given special definitions of these terms which are not equal. Others have written on the assumption that they may be unequal without prefacing their discussion with any definitions at all.

I classify some of the various uses of them which appear to be current. Everyone agrees in meaning by Saving the excess of income over what is spent on consumption.

It would certainly be very inconvenient and misleading not to mean this. Nor is there any important difference of opinion as to what is meant by expenditure on consumption. Thus the differences of usage arise either out of the definition of Investment or out of that of Income.

2. Investment

It means the purchase of an asset, old or new, by an individual or a corporation.

Occasionally, the term might be restricted to the purchase of an asset on the Stock Exchange.

But we also “invest” in a house, a machine, or goods.

New investment, as distinguished from reinvestment, means the purchase of a capital asset of any kind out of income.

If the sale of an investment as being negative investment, i.e. disinvestment, my own definition is in accordance with popular usage; since exchanges of old investments necessarily cancel out.

We have, indeed, to adjust for the creation and discharge of debts (including changes in the quantity of credit or money); but since for the community as a whole the increase or decrease of the aggregate creditor position is always exactly equal to the increase or decrease of the aggregate debtor position, this complication also cancels out when we are dealing with aggregate investment.

Thus, assuming that income in the popular sense corresponds to my net income, aggregate investment in the popular sense coincides with my definition of net investment, namely the net addition to all kinds of capital equipment, after allowing for those changes in the value of the old capital equipment which are taken into account in reckoning net income.

Investment, thus includes the increment of capital equipment, whether it consists of:

• fixed capital
• working capital
• liquid capital

The differences of definition (apart from the distinction between investment and net investment) are due to the exclusion from investment of one or more of these categories.

Mr. Hawtrey, for example, attaches great importance to changes in liquid capital, i.e. to undesigned increments (or decrements) in the stock of unsold goods. He has defined investment as excluding such changes.

In this case, an excess of saving over investment would be the same thing as an undesigned increment in the stock of unsold goods, i.e. as an increase of liquid capital.

I am not convinced by it because it lays all the emphasis on the correction of changes which were in the first instance unforeseen, as compared with those which are, rightly or wrongly, anticipated.

He regards the daily decisions of entrepreneurs concerning their scale of output as being varied from the scale of the previous day by reference to the changes in their stock of unsold goods.

In the case of consumption goods, this plays an important part in their decisions.

But I see no object in excluding the play of other factors on their decisions; and I prefer, therefore, to emphasise the total change of effective demand and not merely that part of the change in effective demand which reflects the increase or decrease of unsold stocks in the previous period.

Moreover, in the case of fixed capital, the increase or decrease of unused capacity corresponds to the increase or decrease in unsold stocks in its effect on decisions to produce.

I do not see how Mr. Hawtrey’s method can handle this at least equally important factor. It seems probable that capital formation and capital consumption, as used by the Austrian school of economists, are not identical either with investment and disinvestment as defined above or with net investment and disinvestment.

In particular, capital consumption is said to occur in circumstances where there is quite clearly no net decrease in capital equipment as defined above.

I have, however, been unable to discover a reference to any passage where the meaning of these terms is clearly explained. The statement, for example, that capital formation occurs when there is a lengthening of the period of production does not much advance matters.

3. Saving and Investment

We come next to the divergences between Saving and Investment which are due to a special definition of income and hence of the excess of income over consumption.

My definition of income in Chapter 6 differed from my present definition by reckoning as the income of entrepreneurs not their actually realised profits but (in some sense) their “normal profit”.

Thus by an excess of saving over investment I meant that the scale of output was such that entrepreneurs were earning a less than normal profit from their ownership of the capital equipment;

by an increased excess of saving over investment I meant that a decline was taking place in the actual profits, so that they would be under a motive to contract output.

The volume of employment (and consequently of output and real income) is fixed by the entrepreneur under the motive of seeking to maximise its present and prospective profits (the allowance for user cost being determined by his view as to the use of equipment which will maximise his return from it over its whole life).

Whilst the volume of employment which will maximise his profit depends on the aggregate demand function given by his expectations of the sum of the proceeds resulting from consumption and investment respectively on various hypotheses.

In my Treatise on Money, the concept of changes in the excess of investment over saving, as there defined, was a way of handling changes in profit, though I did not in that book distinguish clearly between expected and realised results.[1]

I there argued that change in the excess of investment over saving was the motive force governing changes in the volume of output.

Thus the new argument is much more accurate. It is essentially a development of the old: The expectation of an increased excess of Investment over Saving, given the former volume of employment and output, will induce entrepreneurs to increase the volume of employment and output.

My arguments show that the volume of employment is determined by the estimates of effective demand made by the entrepreneurs, an expected increase of investment relatively to saving as defined in my Treatise on Money being a criterion of an increase in effective demand.

But the exposition in my Treatise on Money is, of course, very confusing and incomplete in the light of the further developments here set forth.

Mr. D. H. Robertson has defined to-day’s income as being equal to yesterday’s consumption plus investment, so that to-day’s saving, in his sense, is equal to yesterday’s investment plus the excess of yesterday’s consumption over to-day’s consumption. On this definition saving can exceed investment, namely, by the excess of yesterday’s income (in my sense) over to-day’s income.

Thus when Mr. Robertson says that there is an excess of saving over investment, he means literally the same thing as I mean when I say that income is falling, and the excess of saving in his sense is exactly equal to the decline of income in my sense. If it were true that current expectations were always determined by yesterday’s realised results, to-day’s effective demand would be equal to yesterday’s income. Thus Mr. Robertson’s method might be regarded as an alternative attempt to mine (being, perhaps, a first approximation to it) to make the same distinction, so vital for causal analysis, that I have tried to make by the contrast between effective demand and income.[2]