Wolf knows better. I know he knows

from Peter Radford

What am I supposed to make of this?

Martin Wolf, someone whose work I always pay attention to, flubs it and leaves us with a partial picture.  That’s unlike him.  Perhaps it was the editing?

In any case the notion that the UK needs to generate more savings, which is what Wolf is arguing in his recent Financial Times article, needs a slight augmentation in his basic analysis.

The problem begins when he says that “Investment is financed by savings”.  This is a very un-Wolf like statement.  He is as aware as we are that savings do not cause investment.  This is simply one of those accounting identities that sometimes confuses people into imagining causation where there is none.  This unfortunate sentence then opens the door for the avoidance of the sort of deeper thinking we associate with Wolf.

For instance, whilst the causation does not run savings-to-investment, we could argue that there is causation in the other direction.  Investment in productive projects creates flows within the economy that do, or rather can, create savings.

What’s missing in the article is the relationship between consumption and the availability of productive projects worthy of investment.  Strong levels of consumption provide profitable investment opportunities.  That’s how investment decisions are made.  Banks are willing to provide financing for such projects.  Their credit risk assessment tells them they will get repaid from the profits of projects based on solid consumption prospects.  Banks will create the cash to fund such projects.  That’s the happy advantage of our banking system.  We can invest without having any savings.

In turn, consumption relies on strong income flows throughout the economy.  The more people who have disposable income available to spend on new or additional products the more productive projects will exist.

So the virtuous cycle Wolf would like to bring into being has its beginnings in the availability of that disposable income.  Not in the stock of savings.  High levels of savings, in the absence of strong consumption, simply creates a pile of useless financial assets floating around various Wall Street and City of London balance sheets.

And here’s where we can fault Wolf most of all: the distribution of disposable income throughout the economy really matters when we want to stimulate consumption.  A highly unequal distribution creates the problem I just mentioned.  Since the accumulated spending power is highly concentrated in an unequal society there will inevitably be lower overall consumption.  Such a society will under-consume relative to its apparent wealth and income.  A few people with high levels of spending power is not equivalent to more people each with less spending power.   Wolf doesn’t mention this.

To jump start a poor performing economy where both savings and investment are languishing at unacceptable levels — which is Wolf’s diagnosis of the current UK economy — the policy solution is to distribute purchasing power more evenly throughout society.  Get cash into the hands of people who will spend it rather than tuck it away into financial assets that produce no future increment to our national wealth.

Inequality is not some academic issue beloved only of left of center activists.  It is a factor that has immediate impact on the real economy.  And analysts like Wolf need to make it part of their discussion when they are presenting arguments about depressed levels of savings.

We can give him the benefit of the doubt this time.  After all his focus was on how to develop programs to stimulate savings.

Then again, can we?  His idea that the UK needs to raise the “forced” savings rate from its current level would simply, in the immediate future, depress consumption.  That would reduce the number of productive projects worth investing in and depress investment from its already too low level.

See what I mean?

What am I supposed to make of this?

Let’s be generous: bad editing.  Surely the Financial Times knows better.

Doesn’t it?