Home > Uncategorized > Wolf knows better. I know he knows

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?

  1. February 28, 2023 at 10:23 am

    I too might have expected better from Wolf.
    An excellent critique – thank you. “Such a[n unequal] society will under-consume relative to its apparent wealth and income” encapsulates so much of the contradiction between “We are one of the richest countries in the world” and the poverty and poor economic performance we see all around us.

  2. February 28, 2023 at 12:19 pm

    You’re absolutely right. I took Wolf up on this in a comment on his article to which he replied, see http://www.ft.com/content/0f16f087-ef99-4d8d-90b1-d594afc2c85e?commentID=4a69bca9-ceab-418b-8049-8434042d3bef
    Sadly his new book is worse. I posted a review at http://www.ubi.org/119/
    It’s part of the macroeconomic case for basic income at http://www.ubi.org


  3. Gerald Holtham
    February 28, 2023 at 4:04 pm

    I am afraid there is a confusion here between two different propositions. Peter Radford is talking about the motivation for investment and he is right as far as that goes. People are more inclined to invest when consumption is strong while savings in themselves provide no particular motive to invest. He is also right that if investment occurs and expands the economy, incomes rise and saving and consumption follow. But Martin Wolf was talking about something else – the availability of resources for investment. Yes, you have to want to invest but then you also have to be able to get the kit to do it. Bank finance is available but it has to be able to purchase real resources of labour and materials if the investment is to take place. Wolf was not talking of monetary finance but the provision of real resources. There are two possibilities: you either import the necessaries or the economy has idle resources that you can call into use. Most economies have some idle resources but these won’t provide for a sustained investment boom unless you are in a deep recession.
    If desired investment runs ahead of desired saving on a permanent basis the country will run a current account deficit and be financing the investment by borrowing from foreigners, which may or may not be desirable. If it wants to finance its own investment, consumers can’t be taking up all the production. Adequate saving is not of course a sufficient condition for investment to take place (Radford’s point) but it is a necessary one for home financing of the investment (Wolf’s point).
    The UK, it should be noted, already runs a large current account deficit, which no doubt influences Wolf’s argument.

    • rsm
      February 28, 2023 at 8:52 pm

      “If desired investment runs ahead of desired saving on a permanent basis the country will run a current account deficit and be financing the investment by borrowing from foreigners, which may or may not be desirable. If it wants to finance its own investment, consumers can’t be taking up all the production.”

      BIS Working Papers, No 890, How does international capital flow?, October 2020:

      “First, current accounts are poor indicators of financial vulnerability, because in a crisis, creditors stop financing debt rather than current accounts, and because following a crisis, current accounts are not the primary channel through which balance sheets adjust. Second, we reinterpret the global saving glut hypothesis by arguing that US households do not finance current account deficits with foreigners’ physical saving, but with digital purchasing power, created by banks that are more likely to be domestic than foreign. Third, Triffin’s current account dilemma is not in fact a dilemma, because the creation of additional US dollars requires dollar credit creation by US and non-US banks rather than US current account deficits.”

  4. Gerald Holtham
    February 28, 2023 at 4:07 pm

    PS I absolutely agree with Radford’s point about income distribution, which should be addressed for its own sake. But it won’t tackle the problem that Wolf is discussing.

  5. February 28, 2023 at 6:07 pm

    Geoff, could you post your comment and Martin Wolf’s reply please? I cannot access it on the FT website.

  6. February 28, 2023 at 6:28 pm

    I agree with the Peter Radford’s criticism of Martin Wolf’s acceptance of “investment causes savings”. I too pay attention to Wolf’s views (while not necessarily agreeing with them), but have noticed that he often lapses into orthodox thinking. Radford sets out the standard argument that the degree of prosperity among prospective consumers is a vital component in stimulating investment. High savings are mainly a result not a cause of prosperity. But there is more to it than that.

    The Radford argument neglects the *quality* of investment: the value of an investment is not what it costs, but rather what revenue streams flow from it. Think of the cost and subsequent value of the Google search algorithm. The gap has been described as a “free lunch”, and is central to productivity growth and to new products – and to keeping up with the competition. And it is well known that there has been a “productivity puzzle” in the UK for at least 15 years, along with the investment drought. Too few firms are globally competitive. More investment of the local nail bar type or another branch of Pret will contribute little.

    But also, Wolf’s article focuses mainly on the UK’s international position – the current account. (Can someone explain to me why there is no public discussion of the UK’s chronic deficit, and little within the economics profession as far as I am aware, while government debt gets so much emphasis?) Here it seems to me that “savings” is an odd category. It includes profit, yet is discussed as if it were a question of household behaviour. In both cases, its distribution is *highly* uneven. Most savings go to rich households or individuals (as Radford says), mainly into raising asset prices i.e. real estate and financial assets. *And* to the relatively few firms that are highly competitive internationally and/or have a monopoly position.

    Wolf discusses Singapore. I know little about that situation, but more generally the East Asian model is different from the traditional Western pattern. One could say that in East Asia, savings *do* cause investment, because they are channelled *by the state*. In Singapore, the funds come from forced saving in the form of the Central Provident Fund, in which workers have a personal interest-bearing account based on employers’ and employees’ contributions, not from income tax. Its investments are targeted at public investment that increases productivity – Mazzucato territory – and at meeting needs. The CPF also plays a role in controlling the housing market and the money supply, and there is a significant tax on the unearned value of land – see Roger Sandilands’ FT letter in response to Wolf’s article. We could learn a great deal from the East Asian model by looking at the causal forces – not just the macro data on savings and investment.

    In the UK context, forced savings are rarely discussed. Where would the funds come from? Follow the money: excess profits (windfall; monopoly), plus assets – real estate i.e. a highly progressive land tax and possibly also financial assets, which have been hugely boosted by quantitative easing.

    To return to Radford’s blog, we would still need policies to improve the distribution of spending power in the UK economy, especially among those on lower incomes, as he says. Policies addressing the supply side and inequality/aggregate demand are complementary.

  7. Gerald Holtham
    March 1, 2023 at 12:06 pm

    RSM: money is money. It can buy resources but it can’t immediately conjure them into existence if they don’t exist. Banks can create as much money as they like. For the borrowers to spend that money on something real, something real has to be available. I daresay the BIS quote is out of context because as it stands it is economically illiterate.

    • rsm
      March 1, 2023 at 5:35 pm

      Gerald, would you change your mind about the literacy of the Bank for International Settlements paper quotation, if you knew it came from the abstract (which is supposed to have as little context as possible)?

      May I repeat part of the quotation from the abstract of the BIS Working Paper 890 that I cited before?

      “US households do not finance current account deficits with foreigners’ physical saving, but with digital purchasing power, created by banks that are more likely to be domestic than foreign”

      Can you see how money creation by financial agents easily dwarfs any real trade dollar volumes?

      If this is an empirical question, shouldn’t we turn to the BIS statistics website for figures to back up my claim that since money exceeds GDP by at least a factor of ten, your claim that “something real has to be available” is suspect?

      Are people just buying virtual financial goods whose value can become disconnected from real economic activity? And how can we use that disconnected virtual world to distract offensive ppl from doing real harm in the real world?

  8. Romar Correa
    March 1, 2023 at 12:14 pm

    I agree, Peter Radford. Disbelief in the causation from savings to investment is spreading.
    I would finesse your case a tad. Investment is about PROSPECTIVE consumption. Brisk current consumption will push against capacity and induce investment. Yes, there is no reason for banks not to be on board. And you are right, of course, current consumption is a function of a steady flow of income. Not to make too fine a point of it, it is income PROSPECTS that drive investment.
    Your thesis can be seen more powerfully now, I believe. When the inequality of income is vile and growing, the market for goods and services is small and shrinks. The demand for inessentials and luxuries is narrow. We don’t need to remind ourselves that the propensity to consume of the upper classes is low. Indeed, high savings are a drag on profits, present and future. The dynamic of capitalism is expanding markets and mass production.
    I agree with your policy suggestion but would substitute ‘income’ for ‘cash’. Create jobs in hard and soft infrastructure that cry for attention not only in the UK.
    PS I haven’t seen Mr Wolf’s article but a “forced saving rate” is wrong economics and, even minus the “rate”, not subject to policy.

  9. Gerald Holtham
    March 1, 2023 at 12:14 pm

    If I borrow pounds from the bank and use them for imports, the foreign exporter has to accept and hold the pounds. That means I have transferred a bank liability to him. I borrow from the bank but the bank is borrowing from the foreign exporter. There is still a foreign debt. If he won’t hold the pounds and exchanges them for euros or dollars, his bank supplying that currency ends up with the pounds. If you run a current account deficit you are necessarily incurring foreign debt or reducing foreign assets, in whatever currency the assets are denominated. This isn’t even economics, just simple accounting.

    • rsm
      March 1, 2023 at 5:40 pm

      What if the foreigners are buying dollar-denominated financial instruments from JP Morgan Chase, Goldman Sachs, etc.?

  10. Gerald Holtham
    March 1, 2023 at 12:34 pm

    “(Can someone explain to me why there is no public discussion of the UK’s chronic deficit, and little within the economics profession as far as I am aware, while government debt gets so much emphasis?)”

    It might have something to do with the identity that says the sum of net saving (savings minus investment) by households, the corporate sector and government equals the current account balance. If private saving and investment are in balance a government deficit will equal the current account deficit, by definition.
    Where domestic savings exceed investment the government can run a deficit and leave the current account in balance or surplus (e.g. Japan for much of recent history). Where domestic savings do not exceed investment the government deficit becomes an external deficit.
    This brings us back to Wolf. The UK has low investment but savings are low too so the government deficit results in an external deficit. Just accounting.
    Peter Radford implies that if the government upped its own investment the economy would grow and generate more savings. No doubt true but in the short run there must still be an increase in the external deficit. Would the investment trigger enough growth to create enough savings to reduce the deficit over time? Several UK governments of both parties have tried that “dash for growth” which might in theory work. Every time though it ended in a foreign exchange crisis and retrenchment.
    Wolf is writing against that background.

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