The Online Library of Liberty

A project of Liberty Fund, Inc.

• Preface
• Note.
• Wealth
• Chapter I: The Subject-matter of Economics
• Chapter II: The Fundamental Conditions of Wealth For Isolated Man and For Society
• Chapter III: Co-operation, Or Combination and Division of Labour
• Chapter IV: Population
• Chapter V: The Social Order
• Chapter VI: The Controlling Power of Demand
• Chapter VII: The Control of Provision For the Future
• Chapter VIII: Continuous Power to Demand, Or Income
• Chapter IX: The Classification of Incomes
• Chapter X: The Division of Income Between Owners and Workers
• Chapter XI: Incomes From Ownership of Property
• Chapter XII: Incomes From Work
• Chapter XIII: The Relation Between Individual Income and Individual Wealth
• Chapter XIV: The Wealth of Nations

CHAPTER VII

the control of provision for the future

In the preceding chapter, in order to prevent the main argument being obscured by detail, I have ignored the fact that demand may be either for commodities and services which are wanted at once for immediate ends or for things which are wanted because they will improve people's position in the future.

We have seen that our supposititious Isolated Man would have to be constantly deciding between action which gives immediate results and action which improves his position in the more distant future, and that his decision would be governed by rough estimates of the urgency of present as compared with future wants and of the technical advantages to be obtained in the long run by adopting methods which require effort to be put forth long before fruition instead of “hand-to-mouth” methods. We have seen, too, that Society has also by some means or other to make the same decision.

Now Society as a whole certainly has neither mind nor machinery for making and carrying out such a decision on a straightforward estimate of the comparative urgency of present and future wants and the comparative technical advantage of the different methods of production. The decision is made for it by individuals and by public and private institutions, including the territorial states and their subdivisions, in consequence of impulses derived from various motives. We see that while the bulk of the effort of Society is devoted to serving immediate ends, and in preventing the personal and the outward equipment of mankind from deteriorating, a considerable amount of effort is devoted to the improvement of this personal and outward equipment. We find that each generation teaches the next not only as much as it was taught itself but something more, so that each generation becomes better equipped with knowledge; we find that each generation leaves the material surroundings of mankind not only as good as it found them, but somewhat better, so that each generation is better equipped with tools and has easier access to raw material. We have to ask ourselves “Why?”

A certain considerable amount of the effort devoted to the increase of knowledge is due to a desire for the credit and renown gained by remarkable discovery, to the wish to benefit mankind or that part of it which belongs to a particular race or country, and to the natural itch to discover things which affects every healthy-minded person from his earliest childhood. A portion of the effort devoted to the improvement of material surroundings is due to the desire of individuals that they or their families shall enjoy the advantage of those very improvements in the future. I have, for example, constantly to decide whether to go on with books and papers in confusion or to devote time at once to putting them in order so as to save time in the future and the long run. Many things will affect my mind in making the decision. A change in the extent of my knowledge may do so: I may become acquainted with the invention of the card catalogue, and that may make it more worth while to catalogue the items: the weather may be very good, which will make it less worth while to give up leisure time at the present. So, too, every one who does his own gardening is constantly having to decide whether some little permanent improvement is worth while or not. Wherever large numbers of people live to a considerable extent upon the produce of their own and their family's exertions in agriculture, these direct decisions amount in all to something of considerable importance. Where a state exacts compulsory labour from its subjects, as was the custom with regard to road-making even in Europe till quite recent times, it rests with the State to decide how much of this labour shall be devoted to immediate and how much to distant ends: the State can direct permanent improvements to be made or abstain from doing so.

But at present in our part of the world these cases are exceptional. As a rule when we see people producing things for storage, or building additional houses and factories, or improving land, or doing anything else which we believe likely to improve the position of mankind in the future rather than to satisfy its immediate wants, we do not think they are actuated by fear of the State, nor by the expectation that they or their families will themselves use the things they are producing, nor by philanthropy or patriotism. We know that they do this particular work simply because it pays them to do it. Demand governs the distribution of effort between the production of goods for the present and goods for the future just as it governs the distribution of effort between different kinds of goods for the present. If demand varies in one direction, a larger proportion of the whole effort of Society will be devoted to present goods and vice versâ. What is true of labour is also true of the devotion of property to different kinds of purposes. If demand varies in favour of present goods, there will be more parks and fewer brickfields, more yachts and excursion steamers and fewer tramp steamers carrying iron ore and other materials for future constructions. At any one time there is a particular distribution of resources between nearer and more distant ends which is governed by demand, and what we want to know is what will cause the demand to be varied so as to vary this distribution.

The principal immediate cause is variation in the proportions between what we colloquially call “saving” and “spending.”

The term saving is ordinarily applied exclusively to money. We speak of “saving money” and “saving £100 a year.” The money thus spoken of as “saved” might have been spent on current satisfactions and enjoyments, but has instead been reserved, with the effect of improving the outlook of the saver for the future. A person may have saved simply with the view of postponing the spending till some future period, when a given sum of money will, as he reckons, give him, or possibly his widow or children, something more worth having than what he can buy for himself or his wife and children at the present moment. Saving of this kind takes place in primitive conditions when a man puts away coin in a stocking or in a hole in his thatch in order that he may bring it out again to spend when he is old or sick and consequently unable to work; under more modern conditions it appears when people deposit money in savings banks or pay life-insurance premiums not because the savings banks pay a small interest or because interest accumulates on the insurance premiums, but simply because they think it well to make provision for times when they or their families will be more benefited by the expenditure of the money than they would be if the money were spent at once in addition to what is actually being spent upon them. It is thus true that a certain amount of saving takes place which is not caused by the existence of interest, and some economists have pronounced that a little saving might still take place even if the rate of interest sank to zero. But it must be borne in mind that such saving is only intended to be temporary: the savers intend what they save to be spent again, and that at no very remote date, and if their intention is not frustrated by accident, all that they save will be spent within a very moderate period of years, eighty or so at the outside, and usually much less. Consequently no very considerable accumulation could take place if there were no other motive for saving than the desire to “provide for a rainy day” by collecting a store of money which should be spent on the occurrence of the “rainy day.”

The most powerful motive for saving is supplied at present by the interest, profit, or rent which can be obtained by it. People who are primarily induced to save by the desire to provide for a rainy day are encouraged to persist in their resolve and induced to increase their savings by the fact that they can get interest so long as the capital remains intact, and others are induced to save in the first place because they see that it would be pleasing to receive interest, profit, or rent while retaining the power of spending the savings if they choose at any moment to give up the interest, profit, or rent. “Interest” is obtained when the “money saved” is lent out on condition of the borrower paying periodically a sum called the “interest,” and usually calculated as a percentage on the amount lent, which percentage is spoken of as “the rate of interest,” and in modern times is usually calculated per annum rather than per month or per week. “Profit” is spoken of when the money saved is expended on the purchase of commodities and services which are subsequently sold for more than their cost, and thus bring in a profit or gain: this gain, too, is usually calculated as a percentage, but confusion sometimes occurs in consequence of the facts that the amount expended may be regarded as a whole or in parts and that the gain may come in at more or less frequent intervals. For example, it might be said that a secondhand bookseller was making a profit of 60 per cent. when the speaker was thinking simply of the difference between the price at which he bought books and that at which he sold them, and only 20 per cent. when the speaker was thinking of the whole amount the bookseller had put into the business and the return upon that amount per annum. “Rent” is obtained when the money saved is devoted to the purchase of land which is let for periodical payments agreed on between lender and borrower, or, as it is commonly expressed, between landlord and tenant or owner and lessee; and it is also in common language said to be obtained when the money saved is spent in constructing or buying a house or some other fixed object which is let for similar periodical payments. It is not, however, the practice to speak of rent in percentages. Instead of saying the land or the house yields 5 per cent., we say it yields, say, £100 a year. If we want to relate the yield to the money expended, we say it was bought at twenty years purchase, meaning that the price was equal to twenty times the rent. But this phrase is perhaps becoming old-fashioned, and It is quite possible to say that the land or house yields 5 per cent. on the price paid for it. In any case, it is a question of phraseology, which does not affect the fact that people who acquire property which yields a “rent” are actuated by the same motives as those who use the money they have saved to procure interest or profit. Hence economists have found it convenient to use the term “interest” to cover the whole of the periodical “returns” to savings.

Of course interest is not always equally powerful in causing savings. Changes are possible which will cause any given rate of interest to become more stimulating or less stimulating to saving in two ways.

1. A change may take place which will render the potential savers more desirous or less desirous of providing for the future as compared with the present, although their means of doing so and their knowledge of methods remain the same.

There is little reason to suppose that “providence” is always present in the same degree in the minds of potential savers. Writers and preachers are in the habit of assuming that people usually underestimate future goods as compared with present. There is little ground for the assumption: it is chiefly made by the well-to-do, who do not know what it is to be really pinched in the present. But the fact that the assumption is made, and that people are exhorted to be more “provident,” while nobody thinks of retorting that a change is impossible, shows that it is generally believed that a change in this respect can take place, and here no doubt the general belief is correct.

More important, perhaps, than the obscure psychological change suggested by the phrase “increasing providence,” are the innumerable circumstances which, without any such change and without any change of means, may lead people to be more or less desirous of attempting to improve the future at the expense of the present. More or less certainty about the future is perhaps the most important of these circumstances; we might reasonably expect more to be saved where security prevailed than where the saver ran considerable risk of seeing somebody else enjoy the fruits of his saving. Another important factor is the degree in which wives and children are distributed between the potential savers: a man is more likely to wish to save for his widow and children than for others.

It is very commonly believed that States can alter the total amount annually accumulated directly and very materially by the choice which they can make between taxes which “are paid out of” or “fall upon” income and those taxes which are paid out of or fall upon capital. This belief is founded on a misapprehension. Most actual taxes are supposed to be paid out of income, and the stock example of taxes supposed to be paid out of capital is the inheritance taxes, or death-duties as it has been the custom to call them in colloquial English ever since Gladstone applied that term to them. Obviously, the immediate payers of such taxes, usually the executors or administrators of the deceased, ordinarily pay them out of the proceeds of a part of the property passing from the dead to the living. The money thus obtained is supplied by the purchasers of the property sold, and its ultimate source is the income of the purchasers, or, at any rate, of some persons somewhere who have income to invest. It is because these persons save that the State is able to get the money, and so it seems clear to the attackers of this kind of taxation that it is paid out of capital, which is to its discredit, inasmuch as it is usually regarded as rather discreditable for a State, as for an individual, to live on its capital.

But whether the State takes twenty millions a year from owners of property taken as a whole by taxing each of them a small percentage every year, or takes exactly the same sum from them by taxing each of them a much larger percentage every twenty or thirty years, or whenever any one of them dies, can scarcely make any very material difference in the long run. No one supposes that the small annual percentage must be paid out of capital: why should the larger every-thirty-years or on-occasion-of-death percentage be paid out of capital? The annual tax diminishes the available income left to the owners and available for their spendings or savings, by twenty millions per annum, and the tax levied it certain or uncertain longer intervals does exactly the same.

Taxation does not work in such a direct crude manner as is supposed. But all the same there is a difference between the effect upon saving of different kinds of taxes. The uncertainty of life may, for example, make death-duties “fall upon capital” more than an equivalent annual tax: as people usually think they will live longer than they do, they may, as a rule, underestimate the nearness of the payment, and consequently spend more and save less than they would under an annual tax. Again, all taxation of property, whether capital or income is the standard of the tax, as compared with taxation of labour-income, must somewhat discourage saving. And even in the taxation of commodities, it is possible to discriminate against or in favour of the saving person: taxation of tobacco and whisky is more likely to hit the spendthrift and thus to be paid out of income than taxation of carpets or tricks.

2. A change of means may take place which will make it easier to save. Any one can see that the offer of a given rate of interest will induce rich people–people whose unsatisfied wants of the moment are not urgent–to save larger absolute quantities of money than poor people. It is a commonplace that the savings of the numerous poor are a trifle compared to those of the small section of society which is rich. This is not because the poor are more “improvident” than the rich, but because they cannot afford to save so much. It would be a physical impossibility for them to save so much: they have not got the income.

It may be more difficult to see that a given rate of interest will not only induce the rich to save more absolutely, but will also induce them to save more in proportion to their spendings than the poor. But take two men of similar disposition and, so far as possible, of similar circumstances (e.g., give them the same number of children) the one with £100 a year and the other with £100,000, and consider how they will be influenced by an offer of 5 per cent. for all savings. If either of them saves in any year one-tenth of his income, he will find the income of himself and his heirs increased in all future years by one-twentieth of one-tenth, that is, by 1/2 per cent. Cutting off 10 per cent. of the spendings “of this year, then, will in each case increase the income of all future years by 1/2 per cent., and at first sight it seems as if 5 per cent. interest should induce the two men to save equal proportions of their incomes. But this first impression is erroneous. The advantage of the additional 1/2 per cent. of income is really more to the rich man in proportion to the 10 per cent. of “spendings” forgone than it is to the poor man. It may be difficult to see this if we take a small saving like one-tenth, but if we enlarge the proportion to one-half, the truth becomes obvious. If a man had £50 per annum and a family to bring up, we should think him a lunatic if he insisted on saving £25 per annum: we certainly should not pass that judgment on a man with £5,000 per annum who saved £2,500 per annum. The fact is, that the utility of additional income declines less rapidly as incomes get bigger: or, which will seem perhaps more convincing, though it is the same thing, the utility of each pound of income rises more rapidly as the income decreases. Consequently any given rate of interest will stimulate saving more when people are rich than when they are poor.

But, given certain conditions of desire to provide for the future and of ability to save, the higher the rate of interest the greater the saving. This has been questioned on the ground that there are some people who are determined to save an amount which will bring in a certain income, and if the rate of interest is low, these people will save more than if it is high. The existence of such people may be doubted, and even if a few such exist, they cannot make much difference. If strong cases of difference in the rate of interest be taken, it will be obvious that their determination, however obstinate, will be of no avail. A man earning £500 a year who determines to save enough to get a permanent income of the same amount when he retires at the end of thirty years from now, may do it by living on £350 a year if he can get 5 per cent., free of tax, on his accumulations. But if he could only get 2 1/2 per cent., he would have to live on £45 a year, which would certainly break his determination. Taking all potential savers together, there can be no reasonable doubt that the higher the rate of interest, other things being equal, the greater the savings.

What then determines the rate of interest?

In approaching this question the first thing to do is to disabuse our minds of the confusion engendered by the too literal acceptance of the colloquial phrase, “it will not pay,” applied to proposed investments. Of course it is true that some proposed investments will not pay in the literal sense of the words: they will bring in no return at all, and the money invested in them will be wholly lost. “It will not pay” often means only “it is not worth while to make this investment since there are others open which will give a better return.” At any given moment every one knows that there is some rate of interest which is the lowest that need be taken, and investments which yield less than this as well as those which yield nothing at all are said not to pay. Between the investments which “pay” the current rate and those which would pay nothing at all, there is always an immense number known which would pay something between the current rate and nil. The whole of the known methods of applying savings to the acquisition of new stores and instruments of production, such as machinery for producing cotton goods, or instruments of direct enjoyment, such as theatres and houses, should be supposed arranged in order of profitableness, so that we see some over the profitable level of the moment, 4 per cent. or whatever it may be, and others at lower levels, 3 per cent., 2 per cent., 1 per cent., 0 per cent., and downwards if we like into the minus region. When this is done, we can see that the more savings there are to invest, the lower is the current rate–the rate which is regarded as making an investment “pay “–likely to fall. To be convinced of this we need only suppose the amount coming forward week by week for investment to be doubled. Will not many investments then be made which no one will now look at because they “will not pay”? Will not all existing property yielding fixed sums per annum rise in capital-value, or number of years' purchase, so that the rate of interest obtained by any fresh investor in them will be reduced? Will not every owner of property which does not yield fixed sums, but is subject to the competition of property newly created out of savings, complain that profits are not what they used to be?

The degree in which the rate of interest will be affected by a given quantity of savings will depend upon the magnitude of the field of employment at each rate, just as the number of inches by which a quart of water will raise the level of water in a basin will depend upon the contour of the sides of the basin; there may be a small field between 4 and 3 per cent., a larger one between 3 and 2, and a much larger between 2 and 1, in which case the rate would fall less and less rapidly with given additions to the amount saved: or there may be just the reverse, in which case the rate would fall more and more rapidly: or there may be a large field between 4 and 3, a small one between 3 and 2, and a large one between 2 and 1, in which case the rate would first fall slowly, then fast, and then again slowly.

This would be an end of the matter if all other changes except increase in savings could be neglected. But there are several other important factors.

Firstly, an increase in the numbers of the people works in the opposite direction to saving. The more people there are, the greater the value of any given instruments, whether of production or, like houses, of direct enjoyment, in proportion to given products of labour requiring less saving. It is easy to see that if the population of the Earth were suddenly doubled by an immigration from Mars unaccompanied by any importation of capital or fresh knowledge, the rate of interest would rise enormously, owing to the urgency of the increased population's demand for all kinds of instruments. The unoccupied field of investment would completely alter, and instead of investments at 4 per cent. being “profitable,” perhaps 20 per cent. would be commonly expected and obtained. The gradual increase of population which usually goes on in the world has, of course, exactly the same tendency, though its effect is not so striking.

Secondly, knowledge is continually growing, and additions to knowledge often affect the relative advantage of producing by methods which involve much storage of consumable goods and much provision of instruments compared with the advantage of producing by methods which require little or no stores and instruments. The stock example of an addition to knowledge of this kind is the invention of steam locomotion on iron rails. This provided an enormous extension of the field of investment by showing people a way of investing a large quantity of savings in constructing new level roads by means of cuttings, embankments, tunnels, and viaducts, which was before unknown, and therefore not adopted, although more profitable than other investments which were actually made. This new method being once pointed out, new savings of course went into railway construction instead of being put into other investments yielding less. It is sometimes assumed that all additions to knowledge are like this invention, and thus all tend to raise the rate of interest. But this is a complete mistake. While some inventions increase the comparative advantage of working with stores and expensive instruments, other inventions diminish it. Any one can see that if instead of steam railways, the “wishing carpets” of children's tales had been actually “invented,” so that all that was required to transport persons and goods was a few yards of inexpensive textile fabric, the field for the investment of savings would have been reduced instead of being enlarged, and investment would have been driven further down in the scale of profitableness: it would have been unnecessary to build railways or to improve the existing machinery of transport. There are, of course, no wishing carpets, and we are apt to think that invention in practice always takes the form of the discovery of means which require more elaborate machinery. This is, however, only because the inventions of which we are reminded are those which are called to mind by the presence of the elaborate machinery required to utilize them: the others, which have simplified processes and led to the disappearance of elaborate—or, as we ungratefully say, clumsy—machinery, leave no visible trace and are soon forgotten. Yet they are obviously of great importance—for all we know of even greater importance than the other kind of invention.

The question now arises how well Society is served by the aggregate decision about saving arrived at by individuals and institutions.

At first sight it may appear as if this decision should be perfectly satisfactory. Every individual who saves does so just up to that point at which the rate of interest he gets makes it in his opinion, which is probably as good an arbiter as could be found, just worth his while. Why does A save £100 a year and B only £50? Because A thinks the future advantage which he expects to get by reserving each pound outweighs the present advantage of spending each pound up to a total of £100; beyond that he does not go, because he reckons that it is not worth while to pinch himself in the present for the advantage obtainable in the future. B calculates in exactly the same way, but owing to some difference in his character, needs, or means, the point at which he finds it desirable to stop is reached at £50 instead of at £100. Each of them stops at the margin where the advantage of further saving is just equal to the advantage of further expenditure on immediate wants. Having this in mind we may say that here is another case of correspondence between value and marginal utility, since the rate of interest may be said to indicate the value of saving as compared with spending, since “5 per cent.” means that £100 down and £5 per annum are of equal value. But it must be remembered that the correspondence of marginal utility and value is only true of single persons or of persons exactly similar in circumstances and tastes. In fact, of course, the tastes and circumstances of different persons differ enormously. If we suppose each single person to have perfect judgment, we are justified in saying that each person will be induced by rises and falls of the rate of interest to regulate his saving so as to get the greatest possible good out of his means: he will save just up to the point where future advantage equals present loss, and no further. But as things are, it is not justifiable to say that Society saves just up to that point and no further, even if we suppose that taken all together the potential savers have perfect judgment. The different means of the different persons make it unjustifiable. Obviously a society with institutions like our own would save quite different amounts if there were a very few enormously rich people and the bulk of the population was poor, than if means were more equally distributed. It is true that such a distribution of means would not result in too much saving under the actual conditions: that is to say, it would not be advisable to tell the rich to squander their means in riotous living. It is better that the multimillionaires should go on providing the world with new ships, factories, houses, and such-like things than that they should give more thirty-thousand pound banquets. But it is true that such a distribution would result in more being saved than would be saved under more satisfactory conditions, in which what was taken off the annual amount saved went, say, to buy more milk for half-fed children. Here again then we find that there is a connection between value and utility and a conditional though imperfect harmony.

Variation of the proportion between saving and “spending,” though probably the principal, is not the only important cause of variation in the distribution of effort between the satisfaction of present needs and the improvement of the future position of Society. People are only said to “save” where the acquisition of property is possible. But much effort is expended which tends to improve the condition of mankind in the future but does not involve the acquisition of property by individuals or by private or public institutions. A large portion of the effort spent on additions to the field of knowledge comes under this head. States have, it is true, tried to create in patents and copyrights a kind of property which would play the same part here that ordinary property in material things plays in regard to additions to useful material things. But neither patents nor copyrights go or can go very far in the promotion of additions to useful knowledge, even if made world-wide. Most useful investigation in this direction is carried on not in response to commercial demand, but from the motives suggested near the beginning of this chapter (p. 121). There is no reason to suppose any perfect harmony here. It is probable that much more effort might well be expended in the direction of increasing knowledge. If more was so expended, less would, of course, be left either for savings in the ordinary sense or for the satisfaction of the needs of the present, or perhaps for both purposes, but the advantage obtained from the greater knowledge would more than counterbalance this loss in the long run.