The Importance of the Propensity to Consume

Employment is a function of the expected consumption and the expected investment.

Consumption is, ceteris paribus, a function of net income, i.e. of net investment.

Net income = Consumption + Net investment 

An investment that withholds its actual spending is less favourable to consumption, and therefore to employment.

An example is a house which continues to be habitable until it is demolished.

Let us assume that:

• an annual rent is paid by the tenants.
• the landlord does not spend this money

This money is a drag on employment throughout the life of the house.

• This money suddenly becomes usable in a lump sum when the house has to be rebuilt.

In a stationary economy, all this might not be worth mentioning.

• This is because in each year, the depreciation of old houses would be exactly offset by the new houses built to replace those reaching the end of their lives in that year.

But such factors might be serious in a dynamic economy, especially after a lively burst of investment in long-term capital.

• In such cases, a large amount of investment money is set aside to eventually be used to replace capital equipment.
• Incomes cannot increase until such money is spent.

Thus sinking funds, etc. are provisions to pay for anticipated replacements.

• These tend to withdraw spending power from the consumer long before the actual replacements are done.
• They diminish the current effective demand
• They only increase it in the year in which the replacement is actually made.

If the effect of this is aggravated by “financial prudence” then the cumulative result may be very serious.

Financial prudence here is the “writing off” of the initial cost more rapidly than the equipment actually wears out,

For example, in the US in 1929, the rapid capital expansion of the previous 5 years had led cumulatively to the setting up of sinking funds and depreciation allowances on so huge a scale.

• It required an enormous volume of entirely new investment merely to absorb these financial provisions.

It became almost hopeless to find still more new investment on a sufficient scale to provide for such new saving as a wealthy community in full employment would be disposed to set aside.

This factor alone was probably sufficient to cause a slump. *

“Financial prudence” of this kind was continued to be exercised throughout the slump by those great corporations which were still in a position to afford it, it offered a serious obstacle to early recovery.

In Great Britain at the present time (1935), the substantial amount of house-building and of other new investments since the war has led to an amount of sinking funds being set up much in excess of any present requirements for expenditure on repairs and renewals.

This tendency which has been accentuated, where the investment has been made by local authorities and public boards, by the principles of “sound” finance which often require sinking funds sufficient to write off the initial cost some time before replacement will actually fall due.

This results that even if private individuals were ready to spend the whole of their net incomes it would be a severe task to restore full employment in the face of this heavy volume of statutory provision by public and semi-public authorities, entirely associated from any corresponding new investment.

The sinking funds of local authorities now stand [4] at an annual figure of more than half the amount which these authorities are spending on the whole of their new developments.[5]

The Ministry of Health is not aware how much they may be aggravating unemployment when they insist on stiff sinking funds by local authorities.