Chapter 15. Aggregate Production, Aggregate Spending, and the Role of Saving in Spending

CHAPTER 15

AGGREGATE PRODUCTION, AGGREGATE SPENDING,

AND THE ROLE OF SAVING IN SPENDING

In order to understand many crucial matters in economics, it is essential to have a clear understanding of the subject of aggregate production and aggregate spending, and of the role of saving in spending. The purpose of this chapter is to provide such an understanding. In the course of providing it, I show that what is saved is not only spent rather than hoarded, but is the source of most spending in the economic system, and that the greater is the degree of saving, the higher and more rapidly rising tend to be both total production and total spending as a direct result.

Of necessity, much of the discussion that follows centers on the concept of gross national product (GNP), by which is meant the total of what is produced in the economic system in any given period of time, such as, typically, a year. In this chapter, I use the traditional expressions gross national product and GNP, rather than the recently introduced expressions gross domestic product and GDP, because the authors I quote all use them. For all practical purposes, GNP and GDP are the same. The only difference is that GNP includes the economic contribution of nationals living abroad and excludes that of foreigners residing within the country, while GDP reverses this procedure.

Spending Not a Measure of Output

Before proceeding further, an important preliminary matter that must be dealt with is the fact that the total of the money which is exchanged for goods and services in the economic system is not in any sense a measure of the total output of the economic system. The expenditure of money to buy any given good or service relative to the expenditure to buy any other given good or service can be taken as a measure of the relative amounts of wealth or production involved. For example, the expenditure of $30,000 to buy a Cadillac, versus the expenditure of $15,000 to buy a Chevrolet, can be taken as an indication that the Cadillac represents twice the wealth as the Chevrolet. But the total expenditure of money to buy all the goods and services produced in the economic system is not a measure of those goods and services in any sense. If, for example, the total annual output of the American economic system should sell for $20 trillion rather than $10 trillion, that is in no sense an indication that the production of the economic system has doubled. As was shown in Chapter 12, such a development is likely to be merely an indication that the quantity of money in the economic system has doubled. The quantity of money, not the physical volume of output, is the determinant of the total volume of spending in the economic system. Only under a system of commodity money, i.e., a gold or silver standard, is there any kind even of indirect connection between production and spending, and then it is only insofar as the ability to produce more or less in general results in an ability to produce more or less gold and silver in particular—i.e., only insofar as the ability to produce determines the quantity of money in the economic system. (These observations, of course, do not detract in any way from recognition of the importance of earning money and of the connection between money—

making and productive activity, which, as we have seen, are essential features of a division-of-labor society. 1 )

The fact that the money exchanged for the output of the economic system is not a measure of that output is confirmed by the resort to price indexes in an effort to convert socalled nominal GNP—i.e., GNP in terms of mere expenditure—into a measure of output, that is, into a measure of socalled real GNP. When nominal GNP doubles, say, it is recognized that this in no sense necessarily means that total production has doubled. It may mean merely that the same amount of production is sold at twice the prices. The attempt is then made to convert nominal GNP into a measure of real GNP by means of dividing it by the rise in prices. Thus, it is held, in this particular case, because the doubled nominal GNP is offset by doubled prices, there is no rise in real GNP; but if nominal GNP should triple, say, while prices double, then, it is held, real GNP has increased in the ratio of three to two.

Shortcomings of Price Indexes

It should be realized that even the application of price indexes does not enable GNP to serve as any kind of precise measure of total production. For one thing, price indexes either make no allowance for changes in the quality of products or an allowance that is necessarily highly subjective and more or less arbitrary. Thus, for example, if one enters into a price index the price of “an automobile,” irrespective of whether it is an automobile of 1993 or 1933, one obviously omits something very important, namely, the enormous improvement in automobiles during this time. In so doing, one is led to overstate the price in the later year in comparison with the earlier year. If, however, one attempts to take into account the improvement in automobiles, any allowance one makes is necessarily highly subjective and more or less arbitrary, in that there is no way of knowing just how much more a buyer is getting for his money in 1993 in comparison with earlier years and thus no way of knowing by just how much one should adjust the price of today’s automobiles before entering it into the price index. The problem, of course, applies to practically all goods, inasmuch as the quality of almost every good changes over time, for better or for worse.

In addition, the problem arises of how to weight the changes in individual prices over time. Obviously a change in the price of a relatively minor good, such as carrots, on which people spend only a very small portion of their incomes, cannot be counted as heavily as a change in the price of a major good, such as housing, on which people spend a very substantial portion of their incomes. The change in the price of housing will be entered in the index with a much greater weight than the change in the price of carrots. It will enter with a weight that is greater to the degree that the fraction of total income spent for housing is greater than the fraction of total income spent for carrots. The problem, however, is that the way the expenditure of income is divided between the different goods does not remain the same over time. The consequence is that different overall price indexes will result depending on which year’s expenditure pattern is chosen for determining the relative weights to be assigned to the different price changes. Consider for example, the different weights that must be assigned to changes in the price of personal computers and VCRs depending on whether one takes 1987 or 1977 as the base year.

These problems, of course, are problems apart from the question of converting nominal GNP into a measure of real GNP. They are problems of price indexes as such, irrespective of the purpose for which they are used. In the last analysis, it is difficult to see how the use of price indexes—and thus measures of real GNP—provide any greater actual precision than such qualitative judgments as: there is no perceptible change, there is a slight change, there is a significant change, there is a large, very large, or enormous change.

1. Gross National Product and the Issue of

“Double Counting”: A Is A Versus A Is A+

I turn now to a subject that should be extremely straightforward and simple, but which is complicated by the most profound confusions concerning the nature of entities. Thus, while nothing should be more elementary than the fact that the axiom A is A—a thing is itself—applies to the production and purchase of commodities, it turns out that precisely this is what is more often denied than affirmed by contemporary economics. For the prevailing approach to aggregate production and aggregate spending routinely regards things as being more than themselves—its formula amazingly enough is that A is A+. For example, and this will be demonstrated at great length, it regards a loaf of bread as more than a loaf of bread—namely, as a quantity of flour, wheat, and labor services as well as a loaf of bread, and the purchase of a loaf of bread as the purchase of more than a loaf of bread—namely, as the purchase of flour, wheat, and labor services as well. The prevailing approach represents a systematic confusion between the contents of consciousness—that is, knowledge of connections between things—and independently existing physical entities. In effect, because its practitioners know that bread is made from flour and that flour is made from wheat, they lose sight of the fact that bread, flour, and wheat are distinct entities, and instead jumble them together as

AGGREGATE PRODUCTION AND AGGREGATE SPENDING 675 though they all represented some sort of interchangeable intellectual substance. Indeed, I will show that contemporary economics holds what can only be described as a Platonic-Heraclitean view of the nature of entities. That is, it holds a view of entities not as being independently existing physical objects which man’s mind must grasp, but as being the creation of the human mind in the form of bundles of abstractions which can be put together and taken apart at will to form different entities. I call it Platonic in that it views entities as consisting of concepts or abstractions. I call it Heraclitean in that it views entities as though they represented a kaleidoscopic flux, in which a thing can simultaneously be itself and other things. This is what I mean when I say that instead of the Aristotelian formula that A is A—a thing is itself—contemporary economics goes by the formula that A is A+—a thing is itself plus more than itself. 2

I will begin to make all of this clear by first presenting my own approach to the concept of gross national product.

Common-sense observation implies that the total production—the gross product—of the economic system in any given period of time, such as a year, is the total of all of the goods and services produced in that period of time. It is, for example, the sum of the bread, flour, and wheat, the automobiles, steel sheet, and iron ore, the tractors and auto plants, and all other goods and services produced in the year. (Previous discussion in Chapter 11, of course, makes it clear that in the context of a division-of-labor society, the production to be counted must be confined to production carried on for the purpose of earning money, because all other, merely physical production is, in actuality, consumption. 3 ) This total production is obviously what should be called the gross national product.

Now much of production, of course—indeed, the greater part of it in a modern economy—is the production of means of production—capital goods—which are consumed in the process of further production. In this category fall such products as flour and wheat, and steel sheet and iron ore, as well as the equipment and factory buildings used. All such products are productively consumed in the course of further production. 4

When the total of productive consumption is subtracted from the gross national product, the result can appropriately be termed the net national product (NNP). Net national product, in other words, is simply gross national product minus productive consumption. Net national product represents the gain from production. It is the excess of what is produced over what is consumed in order to produce it, that is, over what is productively consumed.

It turns out that net national product is equal mainly to that part of gross national product which is unproductively consumed—viz., to consumers’ goods and services. This is because the part of gross national product which consists of capital goods is largely netted out in the subtraction of productive consumption. For example, the part of gross national product that is wheat is subsequently productively consumed in the making of flour; the part of the gross national product that is flour is subsequently productively consumed in the making of bread. Thus, the wheat and the flour will not be counted in the net national product, for they are subtracted from the gross national product as productive consumption in the process of arriving at net national product. Only the bread will be counted in net national product, because only it, as a consumers’ good—a “final product”—is not productively consumed in the production of further products.

The nature of gross national product, the process of productive consumption, and the distinction between gross and net national product, is illustrated with quantitative precision in Figure 15–1. In that figure, we have a succession of time periods depicting the production of x 1 bushels of wheat in Period 1, y 1 sacks of flour in Period 2, and z 1 loaves of bread in Period 3. The wheat of Period 1 is productively consumed in producing the flour of Period 2, which in turn is productively consumed in

Figure 15–1

Gross Product and Productive Consumption

Period Bushels of Wheat 1 X 1 2 X 2 3 X 3 4 X 4

Sacks of Flour Loaves of Bread

Y 1

Y 2 Z 1 Y 3 Z 2

producing the bread of Period 3. In Period 2, a fresh supply of wheat, x 2 bushels, is produced alongside the production of y 1 sacks of flour. In Period 3, a simultaneous production of wheat, flour, and bread occurs, which is repeated in Period 4 and, by implication, in all subsequent periods.

Now the gross product of Period 3 is, of course, the sum of the x 3 bushels of wheat plus the y 2 sacks of flour plus the z 1 loaves of bread. The net product of Period 3 is this sum minus the x 2 bushels of wheat and y 1 sacks of flour produced in the preceding period and productively consumed in Period 3. In exactly the same way, the gross product of Period 4 is the sum of x 4 bushels of wheat plus y 3 sacks of flour plus z 2 loaves of bread, while the net product of Period 4 is that sum minus the x 3 bushels of wheat and y 2 sacks of flour produced in the previous period. (In Figure 15–1, the productive consumption of any period is equal to the production of the period before insofar as the latter consists of means of further production.) And again by the principle that everything that is produced is produced, the gross product of Periods 3 and 4 combined is the sum of x 3 plus x 4 bushels of wheat plus y 2 plus y 3 sacks of flour plus z 1 plus z 2 loaves of bread. The net product of these two combined periods is, of course, this gross product minus the combined productive consumption of the two periods, which last is x 2 plus x 3 bushels of wheat plus y 1 plus y 2 sacks of flour.

Figure 15–1 confirms that the net product tends to equal little more than the production of consumers’ goods alone. For example, if in Period 3 the x 3 bushels of wheat produced merely equalled the x 2 bushels of wheat productively consumed, and the y 2 sacks of flour produced merely equalled the y 1 sacks of flour productively consumed, then the net product would be equal strictly to the production of the z 1 loaves of bread alone. This is because the subtraction of productive consumption would completely net out all of production beyond the production of these consumers’ goods. Only to the extent that the production of capital goods is greater or less than the productive consumption of capital goods, does the net product differ from the production of consumers’ goods. To the extent that x 3 bushels of wheat are greater or less than x 2 bushels of wheat, and y 2 sacks of flour are greater or less than y 1 sacks of flour, the net product of Period 3 is greater or less than z 1 loaves by x 3 minus x 2 bushels of wheat plus y 2 minus y 1 sacks of flour.

It should be apparent that to the extent that the production of capital goods such as wheat and flour in a given period exceeds or falls short of productive consumption in that period, the stock of capital goods in existence equivalently increases or decreases. For this reason, the net product in such a case can be said to be equal to the supply of consumers’ goods produced plus this increase or minus this decrease in the supply of capital goods. Indeed, the net product equals the production of consumers’ goods plus the increase or minus the decrease in the supply of capital goods in every case, even when the production and productive consumption of capital goods are equal. (In this instance, the change in the supply of capital goods that is to be added or subtracted can be taken simply as zero.)

The concepts of GNP and productive consumption that I have just presented are essentially those of the British classical economists. For example, Adam Smith writes:

Though the whole annual produce of the land and labour of every country, is, no doubt, ultimately destined for supplying the consumption of its inhabitants, and for procuring a revenue to them; yet when it first comes either from the ground or from the hands of the productive labourers, it naturally divides itself into two parts. One of them, and frequently the largest, is, in the first place, destined for replacing a capital, or for renewing the provisions, materials, and finished work, which had been withdrawn from a capital; the other for constituting a revenue either to the owner of this capital, as the profit of his stock; or to some other person, as the rent of his land. Thus, of the produce of land, one part replaces the capital of the farmer; the other pays his profit and the rent of the landlord; and thus constitutes a revenue both to the owner of this capital, as the profits of his stock; and to some other person, as the rent of his land. Of the produce of a great manufactory, in the same manner, one part, and that always the largest, replaces the capital of the undertaker of the work; the other pays his profit, and thus constitutes a revenue to the owner of this capital. 5

The Smithian view of GNP is propounded by James Mill, another major classical economist, who states: “The whole annual produce of every country is distributed into two great parts; that which is destined to be employed for the purpose of reproduction, and that which is destined to be consumed. That part which is destined to serve for reproduction, naturally appears again next year, with its profit. This reproduction, with the profit, is naturally the whole produce of the country for that year.” 6

Indeed, there is virtually no difference between my view of the gross national product and that of the classical economists. Where I part company from them in this area is only when it comes to the question of what is to be included in the concept of productive consumption and hence in net national product. They frequently, but not always, regard the consumption of the wage earners as productive consumption, which I, of course, do not. As a result, they tend to view net national product as essentially the same as profits, while in my view, when stated in monetary terms, it includes wages as well. 7 The important ground I share with the classical economists here is that of recognizing that the gross national prod—

uct—the total of what is produced in a country in a year—includes the production of everything: for example, flour and wheat as well as bread, and steel sheet and iron ore as well as automobiles. Compared with this point in common, any differences are minor.

Contemporary economics, on the other hand, presents a radically different view of gross national product. It presents GNP as the total output of the economic system. Yet it also claims that GNP is measured exclusively by the amount of final product, which means essentially just consumers’ goods. In Figure 15–1, which shows the successive production of wheat, flour, and bread, contemporary economics would describe essentially only the bread as representing the gross national product! Essentially, only it is the final product. Contemporary economics dismisses goods such as wheat and flour as mere “intermediate products,” which are not to be counted in the gross national product.

The treatment given by Samuelson and Nordhaus is typical. “What is GNP?” they ask. And they answer, “It is the name we give to the total dollar value of the goods and services produced by a nation during a given year.” 8 And then, four pages later, they declare, “GNP, or gross national product, can be measured . . . as the flow of final products . . . .” 9 Indeed, so as to leave absolutely no doubt about it, they emphatically declare that “GNP excludes intermediate goods, i.e., ones that are used up to produce other goods. GNP hence includes bread but not wheat, and cars but not steel.” 10

Now if GNP were presented merely as the total of the final products produced in the economic system, then its measurement as such would be unobjectionable. In that case, however, it would have to be realized that what was being called gross national product was in fact a highly netted national product, that, indeed, it was virtually indistinguishable from net national product as I have described it, namely, as the gross product minus productive consumption. But this is not the procedure of contemporary economics. It advances the concept of gross national product simultaneously as the total output of the economic system—that is, as the true gross product— and as merely the final product of the economic system. Indeed, so ingrained is its confusion between total product and final product that it regards as an error any attempt even to express the actual gross national product! To include the wheat and the steel, according to Samuelson and Nordhaus, is to commit the error of “double counting.” “To avoid double counting,” they explain, “we take care to include in gross national product only final goods and not the intermediate goods that go to make the final goods.” 11 Thus, as I say, the very act of expressing the actual gross national product—the very act of saying that the total of what is produced is the wheat and the flour as well as the bread, the iron ore and the steel as well as the automobiles—is called the error of “double counting.”

Gardner Ackley, who was Chairman of the Council of Economic Advisers under Presidents Kennedy and Johnson, expresses these views as clearly and forcefully as possible:

National product is the economy’s total current output of goods and services valued at the market prices they command . . . .

The main difficulties in computing national product lie in the avoidance of double counting. We should not count as output the bread, the flour that went into the bread, the wheat that produced the flour, and the fertilizer that helped grow the wheat. Despite all the steps in the process, we end up only with bread—bread is the product, not bread plus flour plus wheat plus fertilizer. In other words, we want to count only “final products,” excluding “intermediate products.” 12

The doctrine, so clearly expressed by Ackley, that the final product is the total product has truly amazing implications. Ackley himself has stated one of them when he declares, “bread is the product, not bread plus flour plus wheat plus fertilizer.” True enough, bread may be all that we end up with, but bread is certainly not all that is produced in the course of getting to the bread. The production of the flour, wheat, and fertilizer are no less real and no less a part of total production than the production of bread; and if they were not produced, bread could not be produced. Despite the belief of contemporary economics, the production of bread does not actually represent the production of any of these things. On the contrary, in the mere act of producing bread, one not only does not produce flour, wheat, or fertilizer—one simply consumes flour. In order for the consumption of flour, and thus the production of bread, to be possible, there must be a production of flour. And, of course, in exactly the same way, there must be a production of wheat, to make possible its consumption, and thus the production of flour; and of fertilizer, to make possible its consumption, and thus the production of wheat. The only proper procedure is to acknowledge both the production and the subsequent productive consumption of all such “intermediate goods.”

The incredible view of contemporary economics expressed by Ackley is that it is an error to claim that all that is produced, is in fact produced—that to do so is to claim that more is produced than is in fact produced. Only the bread, we are told, is produced. According to contemporary economics, to claim that the bread plus the flour plus the wheat plus the fertilizer are produced is to overstate the actual amount that is produced.

It follows, according to this view, that such usually reliable publications as The Statistical Abstract of the

United States are in error. For example, the 1986 edition of that publication reports on page 596 that over seven million automobiles were produced in the United States in 1984. The same publication, on page 765, reports a separate figure of over ninety million tons for the production of raw steel in the United States in 1984. The Statistical Abstract clearly informs its readers that both this number of automobiles and this quantity of raw steel were produced in the United States in 1984. And thus, according to contemporary economics, it is guilty of the error of “double counting” and of correspondingly representing the production of the United States as greater than it actually was in 1984. For contemporary economics knows that the production of the automobiles already counts the production of steel and thus to claim that both the steel and the automobiles were produced is to double count the steel. The truth, according to contemporary economics, is that only the automobiles were produced. To paraphrase Ackley, “automobiles are the product, not automobiles plus steel.”

Thus, the contemporary concept of GNP is not only, in actuality, a highly netted-product concept, but it goes so far as to seek to obliterate both the production and the productive consumption of the socalled intermediate products. In so doing, its concept of total production denies the very existence of the far greater part of total production in the economic system.

What underlies the notion that the final product literally is the total product is a bizarre notion of what it is that an individual producer actually produces. According to common sense, the product of a baking company, for example, is bread; that of a flour mill, flour; that of a wheat farmer, wheat. According to contemporary economics, this is a mistake. In its view, what each producer produces is not his product, but the difference between his product and the means of production he uses up in order to produce it. Thus, a baking company does not produce bread, according to contemporary economics, but the difference between bread and flour; a flour mill does not produce flour, but the difference between flour and wheat; and similarly for a wheat farmer and any other producers who may still more indirectly help to make possible the production of bread. This notion is clearly expressed in the textbook of Prof. Lloyd G. Reynolds of Yale University, who writes:

A farmer produces $100 worth of wheat, which is sold to a flour miller. The milling company, by adding labor and capital inputs to this raw material, produces flour which it sells for $150. A baking company uses this flour to produce

$225 worth of food . . . .

How much has the milling company produced? Not its sales revenue of $150, since $100 of this was really produced by the farmer. The milling company’s output is the sales value of its product minus its purchases from the preceding stage of production. We call this the value added at the milling stage, which in this example is $50. 13

It bears repeating: the milling company, according to Professor Reynolds (who speaks for the whole of contemporary economics on this point) does not produce “its sales revenues of $150, since $100 of this was really produced by the farmer. The milling company’s output is the sales value of its product minus its purchases from the preceding stage of production.” Thus, for all the world to see, we have the doctrine baldly stated that producers do not produce their products, but the difference between their products and the means of production they consume in producing them, and, further, that the part of their products that they may naïvely believe they produce, but allegedly do not produce, is produced by their suppliers. No other conclusion is possible when it is kept in mind that the money values involved are supposed to measure underlying physical production.

Thus, according to Professor Reynolds and contemporary economics, producers do not produce their actual physical products but conceptual differences, which represent an abstract part both of their products and of the products of their customers. The wheat farmer, for example, is alleged to produce both wheat minus fertilizer, rather than wheat, and part of the flour allegedly not produced by the milling company.

It is on the basis of viewing the product of the individual producers as conceptual differences rather than actual physical products that contemporary economics arrives at the conclusion that GNP—the total of production—can be measured equivalently either by the value of the final product or by the sum of the values added at each stage of production. If what the baking company produces is bread minus flour, rather than bread; and what the milling company produces is flour minus wheat, rather than flour; and what the wheat farmer produces is wheat minus fertilizer, rather than wheat; and so on, back to the remotest stages of production, then the total product of all these parties combined is, indeed, the bread alone. For in adding up the sum of such differences, all items but the bread cancel out, inasmuch as they all appear as equivalent positive and negative terms. And then, of course, the value of the bread, as the value of the final product, allegedly represents the value of all that is produced.

Now let us look at the socalled value-added approach to calculating GNP. Value added, of course, is the monetary counterpart, the alleged monetary measure, of the conceptual product difference that a producer allegedly produces in place of his actual physical product. Thus, if the product of a baker really were the difference between the bread he produces and the flour (and other previously produced means of production) he consumes in order to

produce bread, then the appropriate measure of his production would be the difference between the value of the bread and the value of the flour (and all other such inputs).

Indeed, all of this can be described in terms of a profound confusion on the part of contemporary economics between the concepts of gross and net product. Contemporary economics believes that what a producer produces is merely the gain entailed in the production of his product, that is, not his gross product but merely his net product. Thus its entire procedure can be described in terms of taking a highly destructive mental shortcut: Namely, instead of going to the trouble of recognizing that producers produce actual physical products and in the process engage in productive consumption, and that the gain from this process is the difference between their production and productive consumption, i.e., the net product, it attempts to leap directly to the net product, as though that were what producers produced. In the process it obliterates the very concepts of the gross product and productive consumption.

Despite contemporary economics, the fact is that each producer produces his product, neither less nor more. By this last, I mean that just as a producer’s suppliers do not produce any part of his product, so he does not produce any part of the product of his customers. The wheat farmer does not produce any part of the miller’s flour, and the miller does not produce any part of the baker’s bread. The wheat farmer produces simply and only wheat, the flour miller, simply and only flour, and the bread baker, simply and only bread. Each party produces only his own product and the totality of his own product. (Interestingly, even contemporary economics recognizes this fact when it fails to urge against antitrust actions based on the fewness of producers, any presence of firms’ suppliers as representing an addition to the number of producers. For example, in an antitrust action against baking companies based on alleged oligopoly, contemporary economics would not be found claiming the presence of tens of thousands of wheat farmers as producers of bread. Its inconsistency on this score is probably to be explained on the basis of what best serves the power of the state.)

The world of contemporary economics is indeed a strange one. By its logic, economics professors do not write books, but the difference between books and paper. When they go home to dinner, they find that their wives have not made a roast beef, say, but the difference between a cooked roast beef and a raw roast beef.

Indeed, the world of contemporary economics is stranger still. Its notion that producers produce conceptual product differences rather than their actual physical products, and that these product differences are present in the products of their customers, ultimately in the final products, is closely bound up with the bizarre, Platonic-Heraclitean notion of the nature of entities I referred to earlier. This is because when one conceives of a final product as being the sum of the alleged product differences of a series of producers, one no longer conceives of that product as a thing that exists independently, out there in reality. Instead, one conceives of it as though it were made up of a bundle of abstractions, namely, the alleged product differences. Thus, for example, instead of conceiving of a loaf of bread simply as the entity a loaf of bread, one conceives of it as the sum of the series of abstractions bread minus flour, plus flour minus wheat, plus wheat minus zero (zero for the sake of brevity and simplicity). As soon as one does this, one is ready to conceive of one and the same given entity as though it were a multiplicity of entities.

Specifically, one is ready to conceive of the final product as though it were the total product not merely in the sense of the sum of alleged product differences or product additions, but in the sense of the sum of all of the actual physical entities involved. That is, for example, one is ready to conceive of bread as being bread, flour, and wheat, and, of course, to conceive of the market value of bread as constituting the market value of flour and wheat as well. Precisely these confusions are present in the conviction of contemporary economics that the value of a final product counts the value of the socalled intermediate products necessary to its production.

The mechanism by which one conceives of a final product as more than itself—as being both itself and all of the previously existing products whose production and productive consumption were necessary to its existence— is that of an improper selective focus. One selectively focuses on different possible combinations of the alleged conceptual building blocks—the conceptual product differences—that are thought of as constituting the final product, and then one sees in each such combination a distinct entity. One then concludes that the final product is itself plus each other such entity. Thus, to continue with the example of bread (ignoring all stages of production prior to wheat farming), one selectively focuses on its alleged conceptual building blocks in three alternative ways that appear to represent distinct entities:

(1) Bread = [(Bread – Flour) + (Flour – Wheat) + (Wheat – Zero)] = Bread

(2) Bread = (Bread – Flour) + [(Flour – Wheat) + (Wheat – Zero)] = Flour + fade out

(3) Bread = (Bread – Flour) + (Flour – Wheat) + [(Wheat – Zero)] = Wheat + fade out

In the first formulation one focuses simultaneously on all three of the conceptual product differences that are

regarded as constituting bread. The holding of all three together in consciousness is indicated by the use of surrounding brackets. In this case, bread is regarded as being bread, which is shown in italic type on the righthand side of the equation.

In the second formulation, one regards bread as flour. One does this by allowing the first conceptual product difference, bread minus flour, to fade from consciousness, as indicated by its placement outside of the brackets. One then focuses on the combination of the two remaining conceptual product differences, which add up to flour. Again, the selective focus is shown by placement within brackets. The result on the righthand side of the equation is flour, in italic type, plus a remainder that is altogether dismissed from consciousness and which I therefore describe as “fade out.”

Finally, in the third formulation, bread is conceived of as wheat. Here the two conceptual product differences, bread minus flour and flour minus wheat, are both allowed to fade from consciousness, and only the remaining conceptual product difference, wheat minus zero, is focused on. Once again, the fading of a product difference from consciousness is shown by its appearance outside of brackets, while the selective focus on a product difference is shown by its appearance within brackets. On the righthand side of the equation, the result is wheat—plus fade out.

In this way, a loaf of bread appears as a loaf of bread, a quantity of flour, and a quantity of wheat. And, of course, it is on this basis that the value of a loaf of bread appears to count the value of the loaf of bread, the value of the flour from which it was made, and the value of the wheat from which the flour was made.

Now as I have said, this is a Platonic-Heraclitean view of the nature of entities. It is a view of entities not as being independently existing physical objects which man’s mind must grasp, but as being the creation of the human mind in the form of bundles of abstractions which can be put together and taken apart at will to form different entities.

It should come as no surprise to learn that the arithmetic implied by such an approach is as bad as the underlying ontology, as the example provided by Professor Reynolds clearly shows.

As we have seen in Professor Reynolds’s example, in the real world a wheat farmer produces $100 worth of wheat, a flour miller produces $150 worth of flour, and a baking company produces $225 worth of bread. Professor Reynolds also includes in his example the further stage of retailing the bread to consumers for $300. Given these assumptions, he then asks:

Now, what is the total output at all stages of production?

Simply adding the sales receipts of the farmer, the miller, the baker, and the retailer would give a total of $775. This is clearly too large. It counts the value of the original wheat four times, the value of the flour three times, and the value of bread twice. 14

After explaining the value-added method as the means of determining the value of the total product, Professor Reynolds continues:

There is another, simpler approach which involves only the value of final output at the point of sale. In our bread example, it’s the value of bread sold by retailers. If we use this method, we can forget about the farmer, the miller, and the baker. Why? Because the value of their output is already included in the retail price of bread. The method yields

$300, the same output figure as the other method [viz., the same as the value-added method] . . . . 15

Professor Reynolds’s conclusion, which speaks for the whole of contemporary economics, that the retail value of the bread counts the wholesale value of the bread, plus the value of the flour and the wheat, rests on the following mistaken procedure. First, the $300 worth of bread at retail is conceived of not as the value of the independently existing entity bread, but as the sum of the values of a series of conceptual product differences, namely: $300 worth of bread at retail minus $225 worth of bread at wholesale, plus $225 worth of bread at wholesale minus $150 worth of flour, plus $150 worth of flour minus $100 worth of wheat, plus $100 worth of wheat minus zero. Next, these value abstractions are taken apart and put together again in different combinations, to form the value of entities other than bread at retail, namely, the value of bread at wholesale, the value of flour, and the value of wheat. In the process, in violation of the nature of an equation, one or more of the constituent value abstractions is allowed to fade from consciousness to the point of totally disappearing from the righthand side of the equation. Finally, the value of bread is taken as constituting the sum of a series of such botched equations, despite the fact that the individual equations exist only as mutually exclusive alternatives and thus are not properly subject to addition. I show all of this in the series of equations presented in Table 15–1.

In these equations, following my practice in the discussion of contemporary economics’ treatment of physical entities, I depict each of the constituent value abstractions within parentheses, in order to show them as the conceptual building blocks of product values that contemporary economics deems them to be. On the righthand side of each equation, I use brackets to depict the combination of these abstractions which is currently “on bright,” as it were, that is, occupies the center of attention and thus determines the particular product value momentarily under consideration. (The particular product value is named directly below the bracketed expression.) The parenthetical expressions standing outside the brackets

Table

15–1

How Contemporary Economics Double Counts the Value of a Loaf of Bread

(and of Consumers’ Goods in General)

(1) $300 =

The value of a quantity of bread at retail

(2) $300 =

The value of a quantity of bread at retail

(3) $300 =

The value of a quantity of bread at retail

(4) $300 =

The value of a quantity of bread at retail are the value abstractions “on dim” at the moment, that is, the value abstractions that have been allowed to fade from consciousness.

Equation (1) in Table 15–1 shows the $300 value of a quantity of bread at retail as equal simply to the value of that quantity of bread at retail, for in this equation all four of the alleged conceptual building blocks of the value of bread are held together on the righthand side of the equation, as shown by their placement inside of the brackets.

Equation (2) in Table 15–1 shows the value of that same quantity of bread at retail as equal to the $75 added by the retailer plus the $225 value of the bread at wholesale. In equation (2), only the last three of the alleged conceptual building blocks of the value of bread are held together, as indicated by their placement inside brackets. It is the sum of these which is $225. The first conceptual building block, the $75 added by the retailer, is placed on dim and thus allowed to fade from consciousness. Accordingly, in this equation, the value of the bread at retail is perceived by contemporary economics as representing the value of the bread at wholesale.

Equation (3) shows the value of the same quantity of bread at retail as equal now to the $75 added by the retailer, plus the $75 difference between the wholesale value of the bread and the value of the flour used to produce it—both of which are now placed on dim and allowed to fade from consciousness—plus, finally, the $150 value of the flour. This last is now on “bright,” by virtue of keeping together only the last two of the alleged conceptual building blocks of the retail value of bread, which is indicated by their placement within brackets on the righthand side of the equation. It is the sum of these

[($300–$225) + ($225–$150) + ($150–$100) + ($100–0)]

The value of a quantity of bread at retail

($300–$225) + [($225–$150)+($150–$100)+($100–$0)]

The value of the bread at wholesale

($300–$225)+($225–$150) + [($150–$100)+($100–$0)]

The value of the flour ($300–$225)+($225–$150)+($150–$100) + [($100–$0)]

The value of the wheat which is $150. Thus, in equation (3), the retail value of bread is perceived by contemporary economics as representing the value of flour.

Finally, equation (4) shows the value of the same quantity of bread at retail as equal to the $75 added by the retailer, plus the $75 difference between the wholesale value of bread and the value of the flour used to produce it, plus the $50 difference between the value of the flour and the value of the wheat used to produce it—all three of which are now placed on dim and allowed to fade from consciousness, as shown by their placement outside of brackets—plus, finally, the $100 value of the wheat. Only this last is now on bright and accordingly takes center stage, as shown by the placement of its value constituent within brackets. Thus, in equation (4), the value of the bread at retail is perceived by contemporary economics as representing the value of wheat.

Now what must be understood from these equations— purely as a matter of mathematics—is that it does not follow that the value of bread at retail counts anything more than itself. All that one is entitled to say consistently with the principles of mathematics is that the $300 value of bread at retail is equal to any one of four different alternative formulations of the same facts. It is equal to either (1) the value of the bread at retail, which is $300, or (2) $75 plus the $225 value of the bread at wholesale, which is still $300, or (3) $75 plus $75 plus the $150 value of the flour, which is once again still $300, or (4) $75 plus $75 plus $50 plus the $100 value of the wheat, which yet once again is still $300.

The importance of the little word “or” between each of these formulations cannot be overemphasized. The value of the bread at retail is equal to four different

alternative formulations, each of whose existence precludes the existence of any of the other three at the same time. Thus, when the value of the bread at retail equals the value of the bread at retail, it does not in addition equal $75 plus the value of the bread at wholesale, or any of its other possible formulations. It is equal to just one formulation at a time. And while three of these formulations may be expressed in a way which highlights components that, considered separately, appear to represent the values of other goods or of bread at the wholesale level, still nothing may actually be omitted from any of the equations. The result is that all four formulations actually continue to represent only the value of bread at retail. In other words, all that is present here are four different ways of expressing the value of one and the same thing, namely, the bread at retail.

This discussion should make clear that contemporary economics commits two major mathematical errors in its belief that the value of bread at retail counts all the other values. First, after expressing the same facts in four different ways, it impermissibly jettisons some of the facts—that is, in equations (2), (3), and (4), it places value abstractions on a level of such dimness, that it simply forgets all about them. It regards equation (2) not as $75 plus the $225 value of the bread at wholesale, but simply as the value of the bread at wholesale—forgetting all about the $75 added by the retailer. It regards equation (3) not as $75 plus $75 plus the $150 value of the flour, but simply as the value of the flour, forgetting all about the first two terms. Finally, it regards equation (4) not as $75 plus $75 plus $50 plus the $100 value of the wheat, but simply as the $100 value of the wheat, forgetting all about the first three terms. It then compounds the error of these omissions by impermissibly adding up mutually exclusive alternatives—i.e., it adds the remaining elements of equations (2), (3), and (4) to equation (1), and reaches the conclusion that the $300 value of bread at retail “counts” $775 in total values. Thus, contemporary economics arrives, implicitly, at the equation

$300 = [($300–$225)+($225–$150)+ ($150–$100)+($100–$0)] + [($225–$150)+($150–$100)+($100–$0)]

+ [($150–$100)+($100–$0)]

+ [($100–$0)].

It is only in this way, that the value of the bread at retail can be made to count itself, the value of the bread at wholesale, the value of the flour, and the value of the wheat.

Thus, paradoxically, as this equation makes clear, it is contemporary economics which is guilty of the error of double counting! It counts the final product as more than the final product—as itself plus all the other products which directly or indirectly contribute to its production. It is on this basis that it concludes that to count the full actual product of the economic system is to count more than is produced. If bread alone is already bread plus flour plus wheat, then bread plus flour plus wheat is more than bread plus flour plus wheat. Indeed, when one considers it, nothing could be more obvious than that contemporary economics double counts. If one believes, as it does, that part of the product—the socalled final product—is the whole product, one must be double counting that part.

2. The Role of Saving and Productive Expenditure in Aggregate Demand

The Platonic-Heraclitean view of entities and the consequent double counting of consumers’ goods is present in contemporary economics’ notion of what constitutes total spending in the economic system. It appears to be present no less in the way the great majority of people think about the process of spending and income formation. For it is generally assumed that in buying consumers’ goods, one buys more than consumers’ goods—that one buys all the means or factors of production, however remote, which have directly or indirectly contributed to the production of the consumers’ goods one buys. (Because the expression “means of production” can be taken to refer exclusively to previously produced means of production and thus to exclude human labor, as when one speaks of “private ownership of the means of production,” it is necessary in the present context to use the expression “factors of production,” which clearly embraces labor along with capital goods.)

Indeed, the confusion is such that it is often assumed that in buying consumers’ goods, one buys, interchangeably, the factors of production that have been used up in the past in producing the consumers’ goods one buys, and the similar factors of production that the seller of the consumers’ goods and his suppliers will buy in the future, in succeeding rounds of expenditure made with the money that one spends for the consumers’ goods in question. To confuse matters even further, it is frequently assumed that in buying a given good, one buys the subsequent goods which will be produced by means of it and that in some sense one buys or pays for things that are physically unrelated to the consumers’ good one buys but that the seller buys with the money one spends in buying from him.

As examples of these confusions, it is assumed that in buying a loaf of bread, one buys the flour and wheat and the labor of bakers and millers that have been used to produce that bread, or have contributed to its production. It is also assumed that one buys the further flour and wheat and labor of bakers and millers which will produce

AGGREGATE PRODUCTION AND AGGREGATE SPENDING 683 or contribute to the production of bread in the future, and which the baker and miller buy in subsequent rounds of expenditure with the sum of money received from one’s purchase of bread. In addition, it is often assumed that the buyer of bread buys toast or a quantity of sandwiches, if such is the use he makes of the bread. And it is also frequently assumed that the buyer of bread buys or pays for things that are physically unrelated to the bread, such as the advertising and research and development outlays of the baking company, or its political and charitable contributions.

In sum, let there be knowledge of a connection between any two things, whether a causal connection in physical production or a connection by way of expenditure with the same physical units of money, and the things become fused together in people’s minds, as though they were one and the same entity.

Such confusions grossly exaggerate the role of consumer spending in the economic system. They make it appear that consumption expenditure is the total of expenditure, allegedly incorporating the expenditure for capital goods and labor, which in reality is made only by business firms, with funds that are not consumed, but saved and productively expended. Moreover, the inability of people to see the role of saving and productive expenditure is compounded by a further set of confusions, which leads them to believe that saving is synonymous with hoarding. Indeed, with such an exaggerated view of the role of consumption expenditure as constituting virtually all spending, there is nothing left for the view of saving except to regard it as hoarding.

The result of these confusions is a “macroeconomics” that is not at all a macroeconomics, but an economics virtually of consumption alone. It is an economics that has virtually obliterated the role of saving and productive expenditure, in the conviction that all economic activity is incorporated essentially just in consumption. It is an economics fully geared to the Keynesian fantasy world in which one not only can eat one’s cake and have it too, but in which one bakes one’s cake in the very act of eating it.

The purpose of the present section is to set matters right by showing the enormous role of saving and productive expenditure in the generation of aggregate demand—a role which far exceeds that of consumption expenditure in size and in most respects is more fundamental than that of consumption expenditure. As an important part of this assignment, it will be necessary to present a system of aggregate economic accounting that, unlike contemporary national income accounting, reflects the full volume of production and the full volume of spending that takes place in the generation of revenue or income. This will be done in Section 3 of this chapter.

The Demand for A Is the Demand for A

The first point that must be driven home by all possible means is the proposition that the demand for A is the demand for A—that is, that the demand for any concrete good or service is simply and only a demand for that concrete good or service; that in buying anything, all that one buys is that which one agrees to receive from the seller and absolutely nothing else.

The plain fact is that in buying a loaf of bread, one buys neither a quantity of flour, nor a quantity of wheat, nor the labor of a baker, nor the labor of a miller, nor a loaf of toast, nor anything else but a loaf of bread. One buys simply and only a loaf of bread, and not anything which has contributed to its production, nor anything which the seller of the bread may subsequently buy and which may thus contribute to the production of bread in the future, nor anything into which the bread itself may subsequently be made. Nor does one make the seller’s political or charitable contributions. The purchase of any and all of these items is fully as much distinct from the purchase of a loaf of bread as these items themselves are physically distinct from a loaf of bread. Their purchase is something totally separate from and in addition to one’s purchase of a loaf of bread.

It is necessary to explain and illustrate this proposition even to the point of belaboring it, because apparently nothing less will suffice to establish it in the minds of most people. Well over a century ago, John Stuart Mill advanced the essentially similar proposition that “demand for commodities is not demand for labour.” His exposition was both clear and, unfortunately, highly prophetic in its recognition that the proposition “is, to common apprehension, a paradox” and thus “greatly needs all the illustration it can receive.” Mill deserves to be quoted at length on this subject:

We pass now to a fourth fundamental theorem respecting Capital, which is, perhaps, oftener overlooked or misconceived than even any of the foregoing. What supports and employs productive labor, is the capital expended in setting it to work, and not the demand of purchasers for the produce of the labour when completed. Demand for commodities is not demand for labour. The demand for commodities determines in what particular branch of production the labour and capital shall be employed; it determines the direction of the labour; but not the more or less of the labour itself, or of the maintenance or payment of the labour. These depend on the amount of the capital, or other funds directly devoted to the sustenance and remuneration of labour. . . .

This theorem, that to purchase produce is not to employ labour; that the demand for labour is constituted by the wages which precede the production, and not by the demand which may exist for the commodities resulting from the production; is a proposition which greatly needs all the illustration it can receive. It is, to common apprehension, a

684 CAPITALISM paradox; and even among political economists of reputation, I can hardly point to any, except Mr. Ricardo and M.

Say, who have kept it constantly and steadily in view.

Almost all others occasionally express themselves as if a person who buys commodities, the produce of labour, was an employer of labour, and created a demand for it as really, and in the same sense, as if he had bought the labour itself directly, by the payment of wages. It is no wonder that political economy advances slowly, when such a question as this still remains open at its very threshold. I apprehend, that if by demand for labour be meant the demand by which wages are raised, or the number of labourers in employment increased, demand for commodities does not constitute demand for labour. I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes; and that it is only by what he abstains from consuming, and expends in direct payments to labourers in exchange for labour, that he benefits the labouring classes, or adds any thing to the amount of their employment. 16

Inasmuch as Mill’s own exposition has passed entirely over the heads of his readers, it is necessary to advance a series of arguments in favor of the proposition that the demand for A is the demand for A, that is, in Mill’s words, actually to give the proposition “all the illustration it can receive.”

i. Shadow Entities and Shadow Purchases

The influence of the Platonic-Heraclitean view of entities leads people to believe such a thing as that the buyer of a loaf of bread is a buyer of flour and wheat, and the labor of bakers and millers, because it leads them to believe that these inputs physically exist in the loaf of bread and thus that its purchase is also their purchase. Such a view, however, has absolutely no connection with the facts of reality and contradicts the law of identity.

If I wish to buy a loaf of bread and a sack of flour and a quantity of wheat, I must buy three separate and distinct items: the bread, the flour, and the wheat. Indeed, I can see myself actually going down the various aisles of a supermarket and picking up from the shelves a loaf of bread, a bag of flour, and, if there is an extensive-enough “health foods” section, a quantity of wheat stalks. My action is very different than if I buy merely a loaf of bread alone. In the one case, I have three items in my shopping cart when I reach the checkout stand, and I pay a sum of money for each of them—one for the bread, another for the flour, and a third for the wheat. I then receive into my possession the bread, the flour, and the wheat. In the other case, I have only one item in my shopping cart—the bread—and when I reach the checkout stand, I pay a sum of money only for the bread and receive into my possession only the bread. If I buy a loaf of bread alone, I do not obtain flour and wheat in addition, or pay out the additional sums required to obtain flour and wheat. The flour and wheat I am nevertheless still supposed to purchase in the mere act of buying a loaf of bread represent, therefore, purchases of a very peculiar kind: they are purchases which cost me absolutely nothing, and purchases which bring into my possession absolutely nothing. In a word, they are purchases which simply do not exist! The only entity I purchase is a loaf of bread, and a loaf of bread is neither flour, nor wheat, nor anything else but a loaf of bread. Indeed, people must dwell in a world of shadows and apparitions if they believe that they obtain bread, flour, and wheat all for the price of the bread alone, all compressed within the wrapper of the bread, and—for many perhaps, best of all—all for the same calories as are present in the bread alone.

Excuse me. Did I imagine eating flour and wheat? That is what those who are deluded by the Platonic-Heraclitean view of entities must believe they eat when they eat bread. In their view, they obtain flour and wheat when they buy bread and so they must believe that they eat flour and wheat when they eat bread. They should stop and think what it would be like actually to eat flour or wheat. I can hear someone now, sputtering and coughing as he gets a mouthful of powdery flour when he takes a bite of bread, or expressing shock and anger when he realizes he is chewing on a stalk of wheat that has managed to find its way into his slice of bread. I can hear the furious denunciations of the baking company for being so incompetent as to allow such things to happen.

If the prospect of eating flour and wheat does not give pause, then one should consider what it would be like to eat fertilizer or tractor parts, which are also supposed to be contained in bread because they have been used to help produce it and which, if bought in the act of purchasing bread, must be eaten in the act of eating bread.

Incredibly, such prospects are unlikely to daunt many of today’s alleged economists. For example, Prof. George Leland Bach, who at the time was a professor of economics at Stanford University, wrote in his widely used textbook: “For example, in converting the iron ore to steel above, Bethlehem adds something to the value of the product it passes along.” 17 The unmistakable meaning of this statement is that a steel company passes along iron ore in the steel it sells—that somehow steel is physically still iron ore. Similarly, Professors Alchian and Allen declare in their textbook: “For example, most steel bought from U.S. Steel by General Motors is not at that time bought by the final user, for General Motors later resells the steel as an automobile.” 18 In these passages, we have the baldly stated view that entities are the means of production that have been used up producing them— that automobiles are the steel sheet from the steel mills and, indeed, iron ore, and that that is what automobile owners drive.

AGGREGATE PRODUCTION AND AGGREGATE SPENDING 685

Indeed, the logic of confusing one thing with another merely because the one was used to produce the other, or merely because the matter that was present in the one now shows up in the other, implies such absurd propositions as that ice is in steam and ice heats houses. For consider. If a quantity of ice is melted into water, and then the water is boiled into steam, then on the same logic as that the wheat and flour are “in” the bread and are eaten when the bread is eaten, and that the iron ore and steel sheet are “in” the automobile and are driven when the automobile is driven, it follows that the ice is in the steam, and that ice heats houses when steam heats houses.

ii. The Need for Capital

If the demand for consumers’ goods really were a demand for factors of production, then one would have to explain why it is necessary to possess capital before starting any business undertaking. Why, if the demand for consumers’ goods is a demand for factors of production, is it not possible for every individual who should happen to be so inclined, to set up his own steel company or railroad line? If it really is the consumers rather than businessmen who pay for the factors of production, then why can’t a prospective entrant into any line of business simply tell the workers he wants to hire and his prospective suppliers that they will be paid by the consumers of the products he will ultimately make possible, and thus should not bother him with their claims?

The truth is, of course, that before entering into any business operation, one must possess the funds required for the purchase of the necessary factors of production, for which purchases one will only subsequently be compensated by one’s customers. These funds, of course, are the capital the firm needs and without which it cannot proceed.

Indeed, for the most part, the customers of business enterprises are other business enterprises. And all those business enterprises which sell to other business enterprises not only require capital of their own, but are dependent upon their customers possessing capital. Such enterprises are not even compensated by the consumers for their outlays, but only by other business enterprises, out of capital. The consumers compensate only those business enterprises for their outlays with which they themselves deal.

iii. Buying the Inputs OR Buying the Output

A further proof that in buying from a business one does not buy what the business buys is the fact that if one really did buy what the business buys, one would not be a customer of the business—certainly not in that transaction. If, for example, one really did buy flour and labor to bake bread, then one would not buy bread—certainly not the bread made from that flour, by that labor. A real buyer of flour and the labor of a baker, compelled to buy bread that is baked from that flour by that labor, would be the victim of a robbery, for he would be forced to buy his own property! His position would be that of being presented with a check for a meal cooked in his own home, by his own housekeeper, with food he himself has paid for. In buying the flour and the labor of a baker, one obtains a natural and a legal title to the bread. One owns the bread by virtue of having bought the flour and the labor. One cannot then be asked to buy the bread.

The principle that follows is that if one really does buy the inputs, one does not buy the output. If one buys the output, it is precisely because one has not bought the inputs.

There is a further difficulty with the confusion that in buying the output one buys the inputs. This is the problem that the demand for the inputs—the demand for the factors of production—is a productive expenditure, while if the output is a consumers’ good, the demand for the output is a consumption expenditure. In such cases, to claim that the demand for the product is a demand for the factors of production, is to claim that an expenditure which is not for the purpose of making subsequent sales— namely, the consumption expenditure which is the demand for the output—is an expenditure for the purpose of making subsequent sales—namely, the productive expenditure which is the demand for the inputs. Thus, it is to claim that one and the same expenditure is and is not a consumption expenditure, and is and is not a productive expenditure.

The Demand for Consumers’ Goods and the

Demand for Factors of Production as Competing Alternatives

It should now be clear that the demand for consumers’ goods is not a demand for the factors of production— viz., capital goods and labor—which were employed in the past in making the production of today’s consumers’ goods possible. The purchase of those factors of production was made in the past, by the current sellers of today’s consumers’ goods and by their suppliers and by a chain of still earlier suppliers. It should be equally clear that the demand for consumers’ goods is also not a demand for the factors of production which will be employed in the future, in making possible the production of possibly similar consumers’ goods, and which will be purchased with sums of money received from the buyers of consumers’ goods in the present. These factors of production too are purchased not by the consumers but by the sellers of today’s consumers’ goods and by their suppliers and a chain of further suppliers. Indeed, once the confusions instilled by the Platonic-Heraclitean view of entities fall

away, one can see that the demand for consumers’ goods is not only not a demand for factors of production, but is in competition with the demand for factors of production.

By this, I mean that to the extent that an individual consumes, he makes impossible the purchase of factors of production. This is because one can buy either consumers’ goods or factors of production, but not both with the same money. Given the quantity of money in the economic system and thus the total ability of people to spend money, a high consumption is most decidedly not the precondition of a high demand for factors of production. If the demand for factors of production is to be high, consumption must be low. For every capitalist or prospective capitalist is faced with the following alternative: He can spend his funds either on consumers’ goods or on capital goods, but he cannot, for example, buy a personal automobile and a truck for his business with the same money. He can spend his funds in the purchase of consumers’ goods for his own enjoyment or he can pay the wages of workers who will render services in his business enterprise, and who will consume in his place, but he cannot, for example, buy a vacation and employ a machinist with the same money. 19

To demonstrate as clearly as possible that the demand for consumers’ goods is in competition with and at the expense of the demand for capital goods and labor by business enterprises, I will show how the demand for consumers’ goods is capable of rising to the point of totally eliminating the demand for capital goods and labor by business enterprises. Thus, let us make the drastic assumption not only that wage earners consume the full amount of their wages but also that businessmen and capitalists, who sell goods and services, use the full amount of their sales receipts to make purchases for their own consumption. In effect, they pay themselves dividends equal to their sales receipts and go out and consume the proceeds. And to close off every last corner, let us also explicitly assume that those who introduce new and additional money into the economic system—that is, gold and silver miners as far as a precious metal standard prevails, and the government and banking system as far as such a standard does not prevail—use the new and additional money exclusively for consumption or to support consumption. In such a case, there would simply be no source of a demand either for capital goods or for labor by business firms. Whatever funds anyone took in from the sale of consumers’ goods would be expended in buying further consumers’ goods, or consumers’ labor, and there would be nothing left with which to buy capital goods or producers’ labor. Precisely this is the situation, described in Chapter 11, that prevails in Adam Smith’s “early and rude state of society” and under Marx’s “simple circulation.” 20

Of course, many will probably still object that the rise in consumption envisioned in this case will place additional funds in the hands of the industries producing consumers’ goods, and that because of this, these industries will be enabled to make a greater demand for factors of production than before. But this objection is absolutely wrong. It fails to take into account that we are assuming a rise in the consumption of businessmen and capitalists, and that this includes the consumption of the businessmen and capitalists faced with the additional demand for consumers’ goods—that, indeed, we are assuming that such businessmen and capitalists, along with all other businessmen and capitalists, consume the full amount of their sales receipts. Thus, there could not only be no increase in the demand for factors of production coming from the industries producing consumers’ goods, but the demand for factors of production coming from those industries would actually fall to zero. Not only would each recipient of additional consumer sales receipts simply reexpend all of the additional sales receipts in the purchase of further consumers’ goods, but he would also expend in the purchase of consumers’ goods the equivalent of all the funds he had previously expended in any given period in the purchase of factors of production. Thus the demand for factors of production emanating from the consumers’ goods industries would be zero, despite the rise in the sales receipts of the consumers’ goods industries.

It is no objection to the assumption that the demand for consumers’ goods rises to the point of totally eliminating the demand for factors of production, to point out that the production of consumers’ goods would then also be almost totally eliminated. For example, it is certainly true that if the demand for the means of producing personal automobiles fell to zero, no personal automobiles could be produced, no matter how high the demand for personal automobiles became. If the assumption actually held that there was only a demand for consumers’ goods and no demand for factors of production, it would certainly be an incalculable disaster. In that case, no consumers’ goods beyond the crudest and most primitive type could be produced, and they, in the most meager quantities. But this is the conclusion to which one comes by way of the proposition that the demand for consumers’ goods is only a demand for consumers’ goods and not a demand for factors of production. It cannot be grounds for attacking that proposition. (What would happen under such conditions is that the division of labor would revert to the most primitive level. The production of products requiring any significant degree of time and temporal succession of producers would become impossible. 21 )

Nor is it correct in this context to say that producers

who expend their entire sales receipts in their own consumption must disappear from the market. If all producers acted this way, then the fact that their products were primitive and few would not be sufficient to drive them out of business, because their competitors would not offer anything better.

Now not only would a rise in consumption spending in the enormous dimensions I have assumed mean a total elimination of the demand for factors of production, but every rise in consumption spending means a fall in the demand for factors of production or, as a minimum, a lesser increase in the demand for factors of production. For even when the quantity of money in the economic system and thus the total ability of people to spend money increases, making it possible for both the demand for consumers’ goods and the demand for factors of production to increase together—even then, the principle holds. This is because the increase in the demand for factors of production would be greater still, if the increase in the demand for consumers’ goods were less. (The same point applies, of course, to increases in the total volume of spending made possible by decreases in the demand for money for holding.) 22

In dealing with less drastic increases in consumption spending—that is, increases in consumption spending not so great as to eliminate the demand for factors of production altogether—it continues to be necessary to keep in mind that a rise in consumption spending does not constitute an increase in the demand for any category of goods but consumers’ goods. It does not increase the total demand for goods in the economic system, but merely changes the composition of that demand. Other things being equal, a rise in the demand for consumers’ goods is accompanied by an equivalent fall in the demand for capital goods. And in the course of a rise in the overall demand for consumers’ goods, the additional demand for many individual consumers’ goods is made possible only by an equivalent reduction in the demand for other consumers’ goods. Thus, for example, in order for businessmen and capitalists to pay themselves larger dividends and thus increase their expenditure for consumers’ goods, they must reduce their expenditure for capital goods and producers’ labor. The only effect this has on the demand for goods as such is to increase the demand for consumers’ goods and equivalently to decrease the demand for capital goods, and, within the demand for consumers’ goods, to increase the demand for those consumers’ goods which may happen to be favored by businessmen and capitalists, and to decrease the demand for those consumers’ goods which may happen to be more commonly purchased by wage earners. That is to say, a rise in consumption spending on the part of the businessmen and capitalists will, for example, increase the demand for personal automobiles at the expense of the demand for trucks for business purposes, and, within the demand for personal automobiles, increase the demand for Cadillacs, say, and decrease the demand for Chevrolets, say. Thus, there is no increase in the total, economy-wide demand for goods as such brought about by a rise in the consumption of businessmen and capitalists, but, as I say, a decrease in the demand for capital goods, for the labor employed by business enterprises, and for the consumers’ goods the employees of business firms would otherwise have purchased. The same is true in principle of all increases in consumption, because they are always at the expense of saving and productive expenditure and thus at the expense of the demand for capital goods and producers’ labor.

It is necessary to clear up the confusion caused by the fact that short of every seller using the whole of his sales receipts to consume, an increase in the demand for any product by consumers tends to result in an increase in the demand for factors of production by the producers of that product. Thus, for example, if wealthy businessmen decided to withdraw funds from their firms in order to consume in the form of buying yachts, say, the effect would normally be to cause an increase in the demand for factors of production by the yacht-building industry. Nevertheless—and this is the essential point—the total demand for factors of production in the economic system would now be less.

For had the businessmen not withdrawn the funds in question to buy yachts, the funds would have been used to buy capital goods, such as various types of machinery or factory buildings, and to pay the wages of workers, who would have bought various consumers’ goods. The demand for these goods—capital goods and the consumers’ goods the wage earners would have bought—does not exist as the result of the use of funds to buy the yachts. Thus the demand for factors of production that would have been made in their production is not made. But it is not the case that all that happens is a shifting of demand for factors of production from the production of these goods to the production of yachts. There is less demand for factors of production in the economic system as a whole. There is less precisely to the extent that the demand for yachts, a consumers’ good, takes the place of a demand for capital goods and labor by business.

In quantitative terms, let us imagine that the new and additional annual yacht purchases of businessmen are $1 billion. To make matters as simple as possible, let us further imagine that these yacht purchases come entirely at the expense of the demand for capital goods. To make matters even more simple, let us assume that they come at the expense specifically of $1 billion worth of tanker purchases. We can readily imagine that as the result of

having $1 billion of additional sales each year, an additional demand for factors of production now takes place every year on the part of the yacht-building industry, in the amount of $900 million, say. However, we are entitled to assume that over and against this additional $900 million of demand for factors of production by the yacht-building industry, there is a $900 million per year reduction in the demand for factors of production on the part of the tanker-building industry. Thus, as far as the yacht-building consumers’ goods industry is concerned, the demand for factors of production has increased by $900 million. As far as the tanker-building capital goods industry is concerned, the demand for factors of production has decreased by $900 million. The overall situation, however, is by no means mutually offsetting or neutral with respect to the demand for factors of production. This is because the outstanding fact of the case is that the demand for capital goods—the tankers—is less by $1 billion and the demand for consumers’ goods—the yachts— is greater by $1 billion. Thus, overall and on net balance, the demand for capital goods is down by $1 billion as the result of the demand for consumers’ goods being up by $1 billion.

Obviously, nothing of significance depends on the assumption that the demand for yachts increases specifically at the expense of the demand for tankers. The capital goods could be of any kind: factory buildings, machines, materials, etc., of whatever description. Nor does anything of significance depend on the assumption that the entire reduction in the demand for factors of production is at the expense of the demand for capital goods. We might imagine that part of it is at the expense of the demand for labor by business. Thus, for example, if $500 million of the funds required for the purchase of the yachts had come from the demand for labor rather than from the demand for capital goods, the demand for factors of production as such would still have fallen by $1 billion. The only complication introduced would have been that the reduction in the demand for labor would in turn have caused a reduction in the demand for consumers’ goods on the part of wage earners and thus that part of the decline in the demand for factors of production offsetting the rise in the demand for factors of production by the yacht-building industry would have been in those consumers’ goods industries rather than in capital goods industries.

What the tanker example is especially suited for illustrating is the effect of a rise in the demand for consumers’ goods at the expense of the demand for factors of production, on the economic system’s subsequent ability to produce. Because yachts have been produced instead of tankers, the result is simply that production in future years will have to take place without the aid of the tankers and will therefore be less. The tankers would have contributed to production in the future; the yachts do not. Of course, this effect on the future ability to produce applies to every increase in the production of consumers’ goods at the expense of the production of capital goods, as we well know from the last chapter. It would apply equally if the production of the yachts had been at the expense of any kind of factory or office buildings, machines or tools, or materials or components purchased by business firms, rather than specifically tankers. The increase in the production of consumers’ goods at the expense of the production of capital goods always means an undermining of the ability to produce in the future.

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It should go without saying that the reduction in aggregate productive expenditure that results from a rise in consumption expenditure also operates to reduce the magnitude of nominal capital in the economic system, inasmuch as nominal capital is the reflection of a series of current and prior productive expenditures. Thus while the yacht-building industry in our example attracts additional capital as the result of the rise in demand for yachts, the total capital of the economic system diminishes. The yacht-building industry does not attract as much additional capital as the rest of the economic system loses in the process.

It may be helpful to put all this in slightly different words: Namely, while every demand for goods—consumers’ goods or capital goods—attracts capital and to that extent underlies an expenditure for factors of production, the amount of capital available to be attracted and the magnitude of the expenditure for factors of production that corresponds to any given demand for goods is the less, the more frequent and the larger in size is the choice of individuals to spend their funds on consumers’ goods rather than on factors of production. 23 A rise in the demand for consumers’ goods at the expense of the demand for factors of production increases the proportion of the demand for factors of production that is made by the consumers’ goods industries while reducing the overall size of the demand for factors of production in the economy as a whole. With a big enough rise in consumption and fall in demand for factors of production, even the expenditure of the consumers’ goods industries for factors of production falls and, indeed, can completely disappear, as we have seen.

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Now it is certainly possible that some businessmen and capitalists who decide to step up their consumption at the expense of their capitals and demand for factors of production might merely put sales revenues into the hands of other businessmen and capitalists who choose to consume more modestly and to make a correspondingly greater demand for factors of production relative

to their sales revenues. To the extent that this is the case, then the rise in the consumption of businessmen and capitalists is only passing, and disappears as soon as greater wealth comes under the control of those businessmen and capitalists who employ a relatively smaller proportion of their sales revenues in their own consumption. This circumstance, however, in no way affects the truth of the statement that consumption and the demand for factors of production move in opposite directions. For when the consumption of businessmen and capitalists rose in this case, the demand for factors of production would still fall, and only then, when the consumption of businessmen and capitalists once again declined, would the demand for factors of production return to its former level.

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I do not want to be perceived as condemning in any way the purchase of yachts or any form of private luxury consumption that takes place under capitalism. Given the security of property that prevails under capitalism and the enormous degree of rationality and future orientation, such consumption takes place in a context of a far greater degree of provision for the future and capital intensiveness of production than under any other imaginable economic system. I chose the example merely in order to make the principle clear that consumption and demand for factors of production are opposites. Furthermore, it is important always to keep in mind that while a further decline in consumption relative to the demand for factors of production can always achieve further economic improvement, it can do so only if it is uncoerced. If the attempt were made to force businessmen and capitalists to restrict their consumption, they would lose the incentive to accumulate and maintain their capital, which would result in far greater economic loss than could possibly be gained by any restriction that might be imposed on their consumption. 24 The only truly destructive consumption expenditure that exists under capitalism (or, more correctly, under a mixed economy) is the wasteful consumption of a government that is no longer confined within the limit of its proper functions. The reduction or, better still, the total elimination of such consumption can represent an enormous economic gain in bringing about a higher relative production of capital goods and a higher demand for labor relative to the demand for consumers’ goods. 25 Indeed, even the seeming beneficiaries of such consumption expenditure must end up being better off without it, when they support themselves through their own work and saving in the midst of a society characterized by economic progress.

Compatibility With the Austrian Theory of Value

It should not be thought that the proposition “the demand for A is the demand for A” or, what is virtually equivalent, John Stuart Mill’s proposition “the demand for commodities is not demand for labour,” is incompatible with the socalled Austrian theory of value, according to which the prices of factors of production are ultimately determined by the prices of the consumers’ goods they help to produce. The proposition is perfectly compatible with the Austrian theory of value. The reconciliation consists in the fact that the value of factors of production relative to one another is determined by the value of their products, ultimately consumers’ goods, relative to one another, but that the value of factors of production relative to the value of their products is not determined by the value of their products. This is simply to say, for example, that insofar as the factors of production in question are specific and cannot be transferred between uses, the means of producing wine will be more valuable than the means of producing bread to the degree that wine is more valuable than bread; but a rise in the total value of wine, bread, and consumers’ goods in general can never mean a rise in the value of the means of producing them, if there is no change on the side of money. On the contrary, if there is no change on the side of money, every rise in consumption must mean a corresponding fall in the demand for and total value of the factors of production.

There is nothing surprising in this. When the Austrian theory of value declares that the value of consumers’ goods determines the value of the means of producing them, it is always on the assumption—either implicit or explicit—that the relationship between the value of the products and the value of the factors of production can be ignored. However, this relationship cannot be ignored when we turn to the theory of profit and interest and the concomitant question of what causes the value of products regularly and consistently to exceed the value of the factors of production. Then the problem is no longer one of the value of factors of production relative to each other, but relative to the value of their products. And here, a rise in consumption increases the margin between the value of products and the value of the means of producing them—viz., it operates to raise the rate of profit and interest. 26 The Austrian theory of value, logically considered, should be taken to mean no more than that the relative value of consumers’ goods determines the relative value of the means of producing them, and this, insofar as the factors of production are specific, that is to say, not substitutable for one another in the different uses in question. As Mill himself put it, “The demand for commodities determines in what particular branch of production the labour and capital shall be employed; it determines the direction of the labour . . . .” To the degree that labor (or other factors of production, such as land) cannot be changed in its “direction,” or cannot be

changed without some loss of efficiency, then changes in the relative value of the factors of production result.

Application to the Critique of the Keynesian

Multiplier Doctrine

The proposition that the demand for A is the demand for A has major application to the critique of the Keynesian “multiplier” doctrine, a doctrine that is expounded in virtually every contemporary textbook that deals with “macroeconomics.” 27

The multiplier doctrine claims that an initial increment of net investment, government spending, or any other “autonomous” expenditure is followed by successive rounds of consumption spending which serve to produce a multiple increase in national income. The proposition that the demand for A is the demand for A shows that the only incomes that could be raised by the successive rounds of consumption expenditure envisioned by the multiplier doctrine would be profits, not wages. As should now be clear, any rise in wages, in the demand for goods at wholesale, or in the demand for capital goods of any kind depends on what is not consumed, but saved and productively expended. This is because consumption expenditure is merely consumption expenditure. It does not incorporate productive expenditure. The demand for goods at wholesale, for materials and machinery, and for labor by business is possible only to the extent that people do not consume but save and productively expend. Yet the Keynesians regard saving as a “leakage” and as allegedly diminishing the amount of subsequent incomes.

It is only on the basis of utterly illusory, nonexistent, shadow purchases of the kind described earlier in this section that the Keynesians can believe that additional expenditure by consumers for the goods and services of business constitute an additional demand for the labor and other inputs bought by business. Moreover, unlike other economists who have never grasped Mill’s proposition and its implicit call for the application of the law of identity to economics, the Keynesians have no escape route. They cannot claim that what they really mean when they propound the multiplier doctrine is only that an inflation-financed rise in consumer demand results in a rise in the demand for labor and other factors of production because business enterprises will spend their additional sales revenues in buying factors of production. The Keynesian analysis explicitly argues that income is raised insofar as the additional incomes corresponding to the additional sales revenues are consumed, i.e., are not spent for business purposes, and that the rise in incomes will be the greater, the higher is the “marginal propensity to consume” and the lower is the “marginal propensity to save.”

Samuelson and Nordhaus propound the Keynesian doctrine in unmistakable terms. They state:

No proof has yet been presented to show that the multiplier will be greater than 1. But the discussion up to now indicates how, when I hire unemployed resources to build a $1000 woodshed, there will be a secondary expansion of national income and production, over and above my primary investment. [Expenditure for a personal woodshed, of course, is consumption, not investment. But no matter.] Here is why.

My carpenters and lumber producers will get an extra $1000 of income. But that is not the end of the story. If they all have a marginal propensity to consume of 2 ⁄ 3 , they will now spend $666.67 on new consumption goods. The producers of these goods will now have an extra income of $666.67. If their MPC is also 2 ⁄ 3 , they in turn will spend $444.44 or 2 ⁄ 3 of $667.67 (or 2 ⁄ 3 of 2 ⁄ 3 of $1000). So the process will go on, with each new round of spending being 2 ⁄ 3 of the previous round.

Thus an endless chain of secondary consumption respending is set in motion by my primary $1000 of investment spending. But, although an endless chain, it is a dwindling chain. And it eventually adds up to a finite amount.

Upon summing up this infinite series, Samuelson and Nordhaus conclude:

This shows that, with an MPC of 2 ⁄ 3 , the multiplier is 3, consisting of the 1 of primary investment plus 2 extra of secondary consumption respending.

The same arithmetic would give a multiplier of 4 if the MPC were 3 ⁄ 4 , for the reason that 1 + 3 ⁄ 4 + ( 3 ⁄ 4 ) 2 + ( 3 ⁄ 4 ) 3 + . . . finally adds up to 4. . . . In other words, the greater is the extra consumption respending, the greater the multiplier. The greater the MPS “leakage” into extra saving at each round of spending, the smaller the final multiplier. 28

Samuelson and Nordhaus are utterly unaware that the overwhelmingly greater part of any income that could possibly be increased by virtue of the process they have described would be profit income. That is the only income that is earned on additional business sales revenue, and business sales revenue is the only receipt that private consumption spending generates (apart from some minor demand for domestic servants). It is also the only receipt that is generated by investment spending insofar as investment spending is for such things as the purchase of the lumber they assume in their example. Thus, for example, if I take $1,000 and go into a shopping mall and spend it in buying clothes, say, my expenditure is $1,000 of sales revenue to the seller of the clothes. The only income earned on those sales revenues is profit, not wages. (Readers who know anything about accounting should be sure to read the next paragraph.) If the seller of the clothes then decides to consume $666.67 of his supposed $1,000 of additional income, say, by going elsewhere in the mall and buying dishes for that sum,

then there is $666.67 of additional sales revenue to the seller of the dishes. Again, any additional income earned is profit, not wages. If the seller of the dishes, in turn, decides to consume $444.44 of his supposed additional income of $666.67, say, in buying shoes, then once again there is only additional business sales revenue, on which the only income that is earned is profit, not wages. In this case, carrying the process to n stages, the effect of the “multiplier”—if it actually existed—would be that the $1,000 of initial additional spending would bring about $3,000 almost entirely of additional sales revenues and hardly any additional wage income. If the additional sales revenues represented equivalent additional net income, the only additional net income they could represent would be profit income, not wages. The only additional wage income would be insofar as the original investment expenditure entailed the payment of wages as opposed to the purchase of capital goods. 29

(In the interest of accuracy, I must point out that in reality, the amount of profit income earned on my $1,000 of expenditure would be less than $1,000 to the extent that the seller had to deduct additional cost of goods sold from his additional sales revenues. The incurrence of additional cost of goods sold, as I will show later on, represents disinvestment, and would actually work to undercut any actual net investment which might have launched the alleged spending chain. 30 In order for my $1,000 of expenditure to constitute $1,000 of additional profit income, we must assume that the seller sells exactly the same total physical volume of goods he otherwise would have sold in the accounting period, but now, thanks to my spending of this $1,000, he does so for $1,000 more of sales revenue. On this assumption, my expenditure of $1,000 would constitute an additional profit income of $1,000 to the seller. A similar assumption, of course, would have to be made for every subsequent round of spending.)

It is true that insofar as business sales revenues rise from year to year, on the foundation of a growing quantity of money and rising volume of spending, the greater portion of the additional sales revenues and accompanying profit incomes is spent by business firms in paying wages and in buying capital goods. But this is a productive expenditure, not a consumption expenditure. It is made out of the portion of the additional sales revenues and profits which are not consumed, but which are saved— something which, as I have said, the Keynesian analysis calls a “leakage,” and regards as unfortunate.

If the economic world operated in accordance with the ideals of Keynesian economics, and the greater part or all of the additional business sales revenues and profits were consumed, it would be disastrous for wage earners and for all business firms that sell to other business firms, and even for those business firms that sell to consumers and which would have higher profit incomes. For the wage share of the national income would fall, the ratio of the value of capital to the value of output, (viz., the degree of capital intensiveness) would fall, and the relative production of capital goods would fall. In short order, economic progress would be brought to a halt and economic retrogression would commence, as capital began to be decumulated. Both real wages and real profits would steadily decline. 31 The interests of everyone in the economic system, but foremost the interests of wage earners, lie with the highest possible productive expenditure, which means: the lowest possible consumption expenditure on the part of those making productive expenditure.

Saving Versus Hoarding

Saving is the use of revenue or income by a business or individual for purposes other than expenditure on consumers’ goods (or consumers’ services). It is revenue or income that is not consumed.

Because what is saved is not spent by the saver for consumption, a popular fallacy has grown up that saving is synonymous with hoarding—i.e., with the retention of money in the manner of a miser. This fallacy is not so difficult to understand when committed by people with limited education, who thus know little beyond their own personal experience. Most such people are wage earners, who normally do not personally make any kind of expenditures but consumption expenditures. In the absence of wider knowledge, it is easy for such people to confuse consumption spending with all of spending and thus to conclude that what is not spent for consumption is simply not spent. But the fallacy is also prevalent in the press, which persists in equating an increase in the rate of saving with a decrease in the spending for goods. For example, whenever it is reported that some increase in the rate of saving has taken place, the press concludes that the effect must be economically dampening at the very least.

Worse still, the fallacy that saving is hoarding is prevalent among professional economists—notably the Keynesians and neo-Keynesians—who routinely describe saving as a “leakage” from the “spending stream.” 32 (Such economists have taught the fallacy to the members of the press.)

Indeed, so complete has been the intellectual severance of saving from spending that for several decades it has been routinely taught in college and university classrooms not only that what is saved simply disappears from spending and depresses the economy, but also that what is invested virtually comes out of nowhere and financially stimulates the economy. 33 This is a state of confu—

sion that would be comparable to believing that the seeds a farmer scatters simply disappear, and that the crop that later comes up, comes out of nowhere. Yet such a state of confusion is the corollary of believing that saving is hoarding. If one recognized that investment comes from saving, one would have to recognize no less that saving goes into investment—that the two are merely different aspects of the same phenomenon. In that case, one would not view saving as depressing, nor investment as stimulating.

It must be pointed out that exactly the same kind of intellectual severance of cause and effect prevails in the belief that government spending represents an increase in total spending, while taxes represent a decrease in total spending. It is not seen that the taxes do no not disappear from spending, but go to finance government spending, and that the government spending does not come out of nowhere, but, for the most part, out of taxes. 34 The objection to taxes is not that they reduce spending but that they transfer the power to spend from those who have earned it, and to whom it belongs, to those who have not earned it, and to whom it does not belong, and in the process reduce the total of what is produced.

It is not possible to emphasize too strongly that saving is not hoarding, for few fallacies are more destructive. Thus, before proceeding to show the actual positive contribution of saving to spending, which is enormous, it is necessary to show some of the fallacies that are present in the belief that there is any real or significant connection between saving and hoarding.

i. The Hoarding Doctrine as an Instance of the Fallacy of Composition

It should be realized that while any particular individual might save in the form of adding to his cash holding—that is, in the form of “hoarding”—it is not possible for the economic system as a whole to do so. Indeed, the belief that the economic system as a whole can save by means of hoarding is an instance of the fallacy of composition—the same fallacy encountered in connection with the belief that not only an individual industry or group of industries can overproduce, but that the economic system as a whole can overproduce. 35

The reason that an individual can save by means of hoarding cash, while the economic system as a whole cannot, is because whatever cash an individual adds to his holding, some other individual has had to subtract from his holding. If I sell my goods for $1,000, say, and decide to retain that sum in the form of cash, it is true that I increase my savings in the form of cash by $1,000. But in the very same period of time, the individuals to whom I have sold my goods have had to reduce their cash holdings, and thus their accumulated savings in the form of cash, by that very same $1,000. I have $1,000 more in cash and in savings, but they have $1,000 less in cash and in savings. Adding up the change not only in my position, but in theirs as well, it thus turns out that in the economic system as a whole there is no increase whatever in savings in the form of cash holdings. What some individuals save by means of adding to their cash holdings other individuals have had to dissave.

The situation of students in a classroom provides an excellent illustration of this proposition. At any given time, the members of the class have just so much cash in their possession. If the doors to that classroom were locked and that class became a “closed economic system” for an hour or so, with its members carrying on some form of production and buying and selling from one another, any individual student might increase his savings by adding to his cash holding over that interval of time. But then the rest of the class must decrease its savings in the form of cash holdings to exactly the same extent. There is no way that the class as a whole can increase its savings by increasing its holding of cash.

It follows that if there is to be saving in the economic system as a whole—that is, an increase in the savings of some or all members of the economic system that is not compensated for by a decrease in the savings of other members of the economic system—the only way it can take place is in the form of an increase in assets other than cash. The increase in the savings of the economic system as a whole must take the form of an increase in its capital assets, such as business plant, equipment, and inventories, or in its consumer assets, such as owner-occupied houses, personal automobiles, and home appliances. In this way, some or all members of the economic system can have an increase in their accumulated savings with no one having to have a decrease. (Consumer assets represent accumulated wealth and thus savings insofar as they retain their usefulness and a corresponding portion of their exchange value. They are consumers’ goods in that they are in the process of being consumed, but they represent wealth and savings insofar as they are not yet totally consumed. Furthermore, the purchase of such consumer assets is frequently made possible by means of borrowed funds, which from the point of view of the lender are capital, inasmuch as they are the source both of their own replacement and of income as well. 36 )

The only exception to the principle that the economic system cannot save by means of adding to its cash holdings exists insofar as there is an increase in the quantity of money. If, over a period of time, the quantity of money in the economic system increases, then, to that extent, there can be an increase in the holding of cash that does not imply an equivalent decrease in the holding of cash by others. But this is the only exception, and it is of

absolutely no negative significance. Moreover, it is inescapable inasmuch as the new and additional money must be added to the cash holdings of someone and in that capacity will constitute part of their savings.

ii. Hoarding as the Cause of a Reduction in Savings

Even though it is impossible that everyone could succeed in increasing his savings in the form of cash holdings (except to the extent that the quantity of money increased), it is possible that many people or even everyone might attempt to do so, in an effort to become financially more liquid. The effect of such an attempt is actually to decrease the aggregate amount of accumulated savings stated in terms of money. This is because the effect of such action is to reduce the monetary value of land and buildings, equipment and inventories, and, of course, stocks and bonds, which are claims against such assets. For all of these things are put up for sale in unusually large quantities, in the general effort to raise cash. At the same time, of course, the expenditures to purchase such assets are sharply curtailed, in efforts to retain cash. The fall in the aggregate monetary value of these items is what causes the fall in the total of accumulated savings stated in money. The reduction in such asset values on the left-hand side of the balance sheets causes a reduction in earned surplus and retained earnings accounts on the righthand side of balance sheets, which accounts represent accumulated savings. Thus, it should be apparent that hoarding is not only not the same thing as saving, but actually operates to reduce the total of what has been saved.

This discussion indicates the true nature of hoarding when it occurs on a significant scale. It has nothing to do with any attempt to save or to save more; nor does it originate with consumers. Rather, it represents the attempt of business firms and investors to convert previously accumulated savings from their usual form of physical assets or claims to physical assets, into cash, in an effort to become more liquid. The attempt takes the form both of the outright sale of existing assets and the reduction of expenditures required for their replacement. And, in the process, as just explained, it reduces accumulated savings, along with consumption and all other forms of spending, and along with all forms of monetary revenue and income.

It should be realized that in such a process, what is saved out of current income easily becomes a negative number. That is, not only is saving out of current income reduced, not only is it wiped out altogether, but, in such circumstances, consumption actually comes to exceed current income. (This was the case, for example, in the Great Depression of the 1930s. 37 ) In part, this is because the contraction in spending that results from the desire to become more liquid initially causes largescale unemployment. To the extent that the unemployed have savings, they live off their savings. Even more important in terms of the size of the effect on savings, the decline in spending in the economic system reduces business sales revenues and profits. Yet even with sharply reduced profits or even outright losses, many businesses continue to pay dividends. Losses, and dividend payments in excess of profits, constitute a reduction in the accumulated savings of business enterprises. And on top of all of this is the capital losses previously referred to, which take place in connection with the sale of assets at prices below their cost of acquisition.

iii. In Defense of “Hoarding”

The fact that “hoarding,” or, more correctly, the desire to increase cash holdings, operates to reduce saving no less than consumption, does not mean that it is an evil or should be prevented in any way. What the attempt to hold more cash does succeed in doing is to increase the buying power of the stock of money, whatever the stock of money may be. (This, of course, is if the attempt to hold more cash is not frustrated by laws interfering with the fall in wages and prices, and by fractional reserve banking in connection with checking deposits, which results in bank failures reducing the quantity of money. 38 ) By virtue of driving down the prices of other assets, of goods in general, and wage rates, it operates to make any given quantity of money stand in a higher ratio to the value of other assets and to spending for goods and labor. It thus operates to increase the degree of liquidity in the economic system and finally to put an end to the desire further to increase cash holdings. To say the same thing in somewhat different words, it operates to increase the socalled quick ratios of corporations and all other businesses and to place them and everyone else in a financially stronger position, in which their cash reserves stand in a higher ratio to their current liabilities, and in which, therefore, the general state of financial solvency is better assured. (Current liabilities are reduced because the fall in wages and prices means that the sums of money owing for any given physical volume of purchases by businesses are correspondingly less.)

If, once and for all, the economic system could achieve a sufficiently high degree of liquidity, and, as a major aspect of this, the threat of mass insolvencies were thereafter removed, there would be no further basis for any contraction in spending. The economic system would operate with less spending relative to the quantity of money (i.e., the socalled velocity of circulation of money would be lower), but that lower relative level of spending would no longer be subject to reduction. From that point on, spending in the economic system could

grow modestly from year to year, in line with a modest rate of increase in the quantity of money. 39

To achieve this highly desirable state of affairs, and, by the same token, to avoid periods in which the economic system is first led into a state of illiquidity through artificial stimulus to overspending, and is thus put in the position in which it requires a financial contraction to restore a sufficient degree of liquidity, what is necessary is a 100-percent-reserve gold standard. This will be shown in Chapter 19, which is devoted to the subject of inflation. 40

Saving as the Source of Most Spending

Apart from the case of occasional misers, revenue and income that is saved is not only spent fully as much as revenue and income that is consumed, but, in the conditions of a modern economic system, is always spent on a far greater scale than revenue and income that is consumed. This is because saving is the source of the demand for all of the labor employed by business firms and for all of the capital goods they buy, such as factory and office buildings, machinery and materials, components and supplies, and goods at wholesale. In addition, it is the source of the demand for all expensive consumers’ goods. 41 Even when it is necessary for business firms to reduce their expenditures for the replacement of assets, in order to build up liquidity, saving—on a gross basis, that is, out of business sales revenues—continues to be the source of far more demand than does consumption.

Nevertheless, the role of saving in spending is almost entirely unappreciated. It is unappreciated even in connection with the purchase of expensive consumers’ goods, despite the fact that the savings of the ordinary wage earner and of many businessmen and capitalists are normally lent to borrowers precisely for the purpose of making possible the purchase of expensive consumers’ goods, notably houses and automobiles. Thus let me begin by pointing out just how dependent is the purchase of expensive consumers’ goods on the existence of savings.

Virtually no one can buy a house out of current income. Very few people can buy an automobile out of current income. Most people cannot buy any kind of major appliance or any other expensive consumers’ good out of current income. To buy any good whose price exceeds the income of the current pay period, or constitutes any substantial portion of the income of the current pay period, which for most people is only a week or two, it is absolutely indispensable that the buyer have access to savings—either his own or those of a lender. There simply is no other way. If a good costs the income of three years, as is typically the case with houses, then there is no conceivable way that it can be bought without savings. Indeed, if a good costs the income of three weeks, its purchase will require savings. If it costs even as much as a third of the income of one week, it will probably require savings if its purchase is to be possible, for it probably could not be afforded if it had to deprive the buyer of so much of his other consumption for the week. Saving exists any time income of one pay period is carried over for expenditure on consumers’ goods in a later pay period.

In view of these facts, it is nothing short of amazing that serious economists and the financial press could believe that saving depresses spending. Saving is absolutely essential to the spending for housing, automobiles, appliances, and every other expensive or even moderately expensive consumers’ good. But these facts only barely begin to indicate the role of saving in spending.

The far greater part of the wages paid in the economic system are paid out of savings. In many cases—especially in manufacturing, mining, construction, and agriculture—the period of time which elapses between a wage earner’s performance of labor and the readiness for sale of the product he helps to produce exceeds the period of time between the wage earner’s performance of labor and the payment of his wages by the employer. For example, a wage earner is typically paid after the performance of one or two week’s work. But the product he helps to produce is often not completed and ready for sale for a much longer period than that. In many cases months, and sometimes several years, go by after the completion of a given worker’s work and the readiness of his product for sale. In such cases, the worker’s wages are paid out of the employer’s capital.

Even in those cases in which the wage earner’s work contributes to the production of a product that can be sold before it is necessary for the employer to pay his wages, it is probable that the employer will not be paid for the product until after he has paid the wages in question. Typically, this is the case whenever the employer sells the product on any kind of credit terms, such as the common practice of giving the customer thirty days in which to pay his bill. In cases of this kind, the source of wages is again clearly the employer’s capital, which, of course, represents accumulated savings.

Finally, even in those instances in which the wage earner’s work contributes to the production of a product or service for which the employer is paid by the customer prior to the payment of the wage earner’s wages—such as the case of a waiter or waitress in a restaurant whose customers usually pay in cash rather than by means of credit cards—the payment of the wages still rests on an act of saving, in that the wages are paid with revenues that belong to the employer and which he does not consume. The employer’s payment of wages in such cases is still a productive expenditure, not a consumption expenditure. And to make it, the employer must not

consume, but save the sales revenues in question.

The only wages in the economic system that are not paid out of savings and which are in fact paid by consumers are wages paid not for the purpose of making subsequent sales, i.e., wages paid not for business purposes. The leading examples are the wages of domestic servants and the wages of government officials. And even though the government’s payroll is certainly grossly excessive, the proportion of total wage payments in the economic system as a whole that is constituted by consumption expenditure is relatively modest notwithstanding. This is indicated by the fact that while in the United States there are some 18.6 million government employees, whose wages represent consumption expenditure, there are over 90 million employees of private business firms, whose wages represent productive expenditure. 42

Not only are most wages paid out of savings and constitute productive expenditure, rather than consumption expenditure, but, as I have indicated, the same thing is true of the purchase of goods as well. All the goods which businesses purchase at wholesale are paid for out of savings, and the funds expended constitute productive expenditure. All of the machinery, equipment, furnishings, fixtures, factories, and office buildings that businesses buy or pay to have constructed, all of the purchases of materials, components, parts, supplies, fuel, lighting and heating, and so forth that businesses make are paid for out of savings and constitute productive expenditure.

When such purchases—which, of course, must be described as purchases of capital goods—are added up, it is virtually certain that they substantially exceed the purchases of consumers’ goods. For example, the sum of the purchase of groceries at wholesale by supermarkets and grocery stores, plus the expenditure for food products by the wholesalers, plus the expenditure for the various ingredients and other supplies by the food processors or manufacturers (which almost always take place at more than one stage of production), plus the expenditure for such things as feed and fertilizer by the farmers, plus the expenditure by all the parties involved for machinery, equipment, fixtures, buildings, power and light, and the like, plus the further expenditures for capital goods by the makers of these things—all these expenditures for capital goods taken together almost certainly add up to substantially more than the expenditure for groceries by consumers at the one, final stage that is constituted by retailing.

Essentially the same principle applies to the cases of clothing, housing, and transportation, and to the economic system in general. Thus, the expenditure to buy capital goods almost certainly exceeds the expenditure to buy consumers’ goods. (It necessarily must do so if the percentage of sales revenues of the average business that corresponds to its costs on account of capital goods, including services purchased from other business firms, is anything greater than 50 percent. If, for example, it were 60 percent, then taking the demand for consumers’ goods as 100, the demand for capital goods would be expressible as equal to the sum of .6 x 100 + .6 2 x 100 + .6 3 x 100 . . . + .6 n x 100, which ultimately equals 150.)

Even if the expenditure to buy capital goods by itself did not exceed the expenditure to buy consumers’ goods, it would still be the case that total productive expenditure, which includes both the demand for capital goods and the demand for labor by business together, far exceeds consumption expenditure. For example, in the case of supermarkets, where the average profit margin is only 2 percent or less, the implication is that 98¢ of every dollar of sales is productively expended (which is why costs come to equal 98 percent of sales revenues). If, of these 98¢ of productive expenditure by the supermarkets, 60¢ are for capital goods whose sellers earn, say, a 10 percent profit margin and productively expend 90 percent of their sales receipts, then, already, productive expenditure equals $1.52 for every $1 of sales receipts from consumers—that is, it equals 98¢ plus 54¢. Of course, it will equal substantially more when the productive expenditures of still more remote stages are added in. Such a relationship between productive expenditure and consumption expenditure prevails throughout the economic system.

It should be realized that not only do saving and productive expenditure far exceed consumption expenditure, but also that they are the source of almost all consumption expenditure. The wages paid by business enterprises are the source of most consumption expenditure in the economic system, in that they provide the great majority of people with the incomes out of which they consume. They are also the source of all that consumption expenditure of the government and its employees which is financed with taxes paid out of the wages of the employees of business enterprises.

For the rest, business—in the productive process—is the source of almost all other consumption. What it does not provide for consumption in the way of wage payments, it provides in the way of dividend and interest payments and in the taxes that it itself pays. The only consumption expenditure of which business is not the source is consumption out of newly created fiat money.

From the perspective of the economic system as a whole, consumption depends on saving and the productive process—not only in physical terms, but in terms of the financial process of paying out and taking in money. As subsequent discussion in this section and throughout this book will confirm, from the perspective of the economic system as a whole, it is the consumers who are

dependent on business, not business on the consumers. The wellknown dependence of business on the consumers, which the Austrian school has done so much to demonstrate, and which I myself have elaborated upon in previous chapters, exists at the level of the individual firm and industry, where competition prevails. But at the level of the economic system as a whole, the competition of the individual firms and industries is mutually offsetting, and there the consumers are dependent on business.

The “Macroeconomic” Dependence of the

Consumers on Business

As I have said, from the point of view of the economic system as a whole, it is the consumers who are dependent on business, not business on the consumers. Any individual business, any individual industry, to be sure, is always vitally dependent on its customers, and, in the last analysis, on the customers for the final products—the consumers’ goods—it directly or indirectly helps to produce. But this is because of the existence of competition among the different business firms and the various industries. The consumers have the power to choose which individual business firms and individual industries will receive back the funds they have provided the consumers with— which will receive back more and which will receive back less. But it is nothing but the fallacy of composition to generalize from this “microeconomic” dependence of the individual business and industry on the consumers to a “macroeconomic” dependence of business as a whole on the consumers. When the entire business system is viewed at once, the consumers have no alternative but to spend. Their desire to live and enjoy life impels them to spend. And, of course, their savings, made as provision for the future, are also spent—by virtue of being spent for business purposes, by virtue of being lent to borrowers who spend them either for business purposes or for consumption, and, to some degree, by virtue of being spent for consumption by the savers themselves, later on.

Thus, at the level of the economy as a whole, the dependency is not that of business on the consumers, but, as I say, of the consumers on business. As we shall see, business is in no way dependent on the existence of any definite minimum demand for consumers’ goods, for the demand for capital goods is as much a demand for the products of business as is the demand for consumers’ goods. 43 At the same time, the consumers are vitally dependent on business for their physical means of survival, well being, and enjoyment. As a result, whatever cash they possess is pulled toward business with the force of a magnet, as it were. At most, it is only a question of how soon they will be drained of all the cash they possess, unless they find ways of continually replenishing their cash by obtaining fresh funds from business, in exchange for the sale of their labor or in the form of dividends or interest paid by business. The phrase “circular flow of income and expenditure,” so popular in today’s macroeconomics textbooks, with its implied equality of dependence of consumers on business and business on consumers, is inaccurate. The fact is that money comes to goods—automatically, on the strength of people’s desire to live and enjoy themselves. What is not automatic, but requires the continuous exercise of intelligence, will, and effort is the process of production.

Consequently, the consumers are dependent on business not only for the production of the products they buy, and thus for the purchasing power of the money they spend in buying them, as I showed in Chapter 13, but also for the monetary means of buying them. Apart from the creation of fiat money (which is always a process that tends to undermine production and thus, in the long run, the ability to consume), it is only the expenditures and disbursements of business enterprises that place money in the hands of consumers; only to the degree that one contributes to the production of products to be sold or receives money from those who do, can one obtain the monetary means of consumption.

i. Business as the Source of Its Own

Demand and Profitability

Consistent with the preceding, business does not need any outside class of consumers—any deliberately created class of consumers. It itself generates a monetary demand that is fully sufficient for the profitable sale of its products. It does so in the mere fact of purchasing capital goods and paying wages and in declaring dividends and paying interest. In addition, the very increase in production itself operates to add further to both the real and the nominal rate of profit (the latter insofar as part of the increase in production is an increase in the supply of precious metals, with the result that under a system of commodity money the by-product of the increase in production is an increase in the quantity of money). I will show all of this in the next chapter, which sets forth my theory of profit and interest, namely, the net-consumption/net-investment theory.

The existence of depressions does not contradict the truth of any of these propositions. The wiping out of profitability that accompanies a depression is the result of a reduction in productive expenditure, which reduces the demand for capital goods, wage payments, and the consumption expenditure of wage earners. Profits are slashed because while these developments reduce the sales revenues of business, its aggregate costs continue to reflect the higher levels of productive expenditure prevailing in the past.

The reduction in productive expenditure, in turn, is

the result of a need of business firms to rebuild their cash balances relative to their outlays and revenues, which need arises because a preceding inflation and credit expansion first induced them to run down their cash balances relative to their outlays and revenues, and to incur unduly large debts besides. The problem of the decline in productive expenditure and sales revenues is compounded by the decline in the quantity of money that can occur under a system of fractional reserve banking.

The solution to the problem of monetary contraction and the wiping out of profitability it engenders is to establish a monetary system which prevents undue increases in the quantity of money, and which prevents decreases in the quantity of money. In preventing the undue increases in the quantity of money, the consequent unduly low level of demand for money for holding would also be prevented, and thus the resulting potential for sudden sharp increases in the demand for money for holding would be eliminated. (For example, in the absence of credit expansion, businessmen would not be misled into believing that they could substitute the prospect of obtaining loans easily and on profitable terms for the holding of actual cash balances. They would thus not be faced later on with the need suddenly to rebuild their cash holdings when the credit expansion was succeeded by a socalled credit crunch.) In these ways, the potential for depressions would be eliminated. Under such a monetary system, productive expenditure and sales revenues would show a modest increase from year to year, accompanying the increase in production and its by-product a modest increase in the quantity of commodity money. Corresponding to the increase in the quantity of commodity money, the nominal rate of profit would, as I say, be moderately elevated. Such a monetary system is, of course, a 100-percent-reserve gold standard.

But even without such a monetary system, business again and again recovers from the depressions inflicted upon it. Once wage rates adjust to the lower level of productive spending, and assets and indebtedness are written down, then, as the net-consumption/net-investment theory of profit will show, virtual “springs” to the restoration of profitability come into play, which act as a guarantee of recovery. 44 ii. No Need for Artificial Consumption

The corollary of the fact that business is the source of its own monetary demand and profitability is that consumers have absolutely nothing of value to offer business that is apart from their contribution to the productive process. The money they spend in buying from business is of value to business only insofar as they have first received it from business, in connection with such contribution. In the case of the consumption of wage earners, business first receives services equivalent in monetary value to the means of consumption which it places in their hands. In the case of the owners and creditors of business enterprises, consumption is a matter of those whose activity underlies and guides the whole productive process consuming a portion of their own property. If it were financed on a voluntary basis, no criticism could be made even of the government’s consumption insofar as it was for the purpose of carrying out its strictly limited and indispensable functions, which are an essential safeguard of the productive process. 45

But it is an altogether different matter when consumption takes place allegedly in order to benefit business by the very fact of its being consumption. Such consumption, which invariably takes place in the form of unnecessarily large government spending, whether financed by additional taxation or by an expansion of the money supply, can only be detrimental to business. If the government imposes additional taxes on business to finance its additional expenditures, then what it does is first reduce the cash holdings of business, and then restore them in the purchase of its products. The effect is that the government consumes without giving business anything in return. Indeed, to produce for the government’s consumption, business is correspondingly prevented from producing capital goods for its own use or consumers’ goods for the consumption of its employees and owners and creditors. The taxes it pays deprive it of the ability to purchase capital goods and to pay wages, dividends, and interest. The taxes thereby reduce the demand for capital goods and for consumers’ goods by wage earners and dividend and interest recipients. Thus, the government’s demand takes the place of these demands.

If the taxes are imposed directly on wage earners, then the government’s consumption is mainly substituted for their consumption, and the loss falls mainly on them, with the likely outcome that their motivation to work is reduced.

If the taxes are imposed directly on dividend or interest recipients, the effect is largely the same as if they were imposed on business enterprises themselves, for it is to reduce the demand for capital goods and labor. Indeed, this is the overwhelming effect in both cases—that of business enterprises themselves and dividend and interest recipients—inasmuch as the consumption of businessmen and capitalists is governed mainly by the size of their capitals rather than their aftertax incomes, and will thus be reduced relatively little by the taxes, which means that the taxes will fall mainly on saving and productive expenditure. 46

If the government finances its additional expenditures by means of an expansion of the money supply, then in return for what it consumes, it gives money. But the

additional money is of no benefit to the economic system, for either in the very spending of it prices are correspondingly increased or prevented from falling, with the result that the government’s added purchases come at the expense of the reduced purchases of the citizens, or inventories are drawn down, thereby leaving business with more money but a smaller supply of assets with which to carry on production. In addition, all the other destructive effects of inflation ensue. 47

In closing this discussion of artificially created consumption, it is appropriate to quote the words of John Stuart Mill on the subject:

It is not necessary, in the present state of the science, to contest this doctrine in the most flagrantly absurd of its forms or of its applications. The utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained. Taxes are not now esteemed to be “like the dews of heaven, which return again in prolific showers.” It is no longer supposed that you benefit the producer by taking his money, provided you give it to him again in exchange for his goods. There is nothing which impresses a person of reflection with a stronger sense of the shallowness of the political reasonings of the last two centuries [the seventeenth and eighteenth], than the general reception so long given to a doctrine which, if it proves anything, proves that the more you take from the pockets of the people to spend on your own pleasures, the richer they grow; that the man who steals money out of a shop, provided he expends it all again at the same shop, is a benefactor to the tradesman whom he robs, and that the same operation repeated sufficiently often, would make the tradesman’s fortune.

In opposition to these palpable absurdities, it was triumphantly established by political economists, that consumption never needs encouragement. All which is produced is already consumed, either for the purpose of reproduction or of enjoyment. The person who saves his income is no less a consumer than he who spends it: he consumes it in a different way; it supplies food and clothing to be consumed, tools and materials to be used, by productive labourers. Consumption, therefore, already takes place to the greatest extent which the amount of production admits of; but, of the two kinds of consumption, reproductive and unproductive, the former alone adds to the national wealth, the latter impairs it. What is consumed for mere enjoyment, is gone; what is consumed for reproduction, leaves commodities of equal value, commonly with the addition of a profit. The usual effect of the attempts of government to encourage consumption, is merely to prevent saving; that is, to promote unproductive consumption at the expense of reproductive, and diminish the national wealth by the very means which were intended to increase it. 48

Saving as the Source of Increasing Aggregate

Demand, Both Real and Monetary

Saving is not only the source of most spending at any given time, but it is also a vital source of the increase in aggregate real demand. Our discussion of Say’s Law has shown that aggregate real demand is determined by aggregate supply. 49 We have also seen that saving vitally contributes to the increase in aggregate supply by bringing about the dedication of a sufficiently high proportion of existing factors of production to the production of capital goods, which, in turn, makes possible capital accumulation, a rising productivity of labor, and thus an increasing supply of goods coming to market. We saw too that it contributes to the same result insofar as it raises the degree of capital intensiveness in the economic system and thereby permits the implementation of a wider range of technological advances. Thus, saving operates to increase aggregate real demand. 50

Previous discussion has also shown that there is no fundamental scarcity of any natural resource, including the precious metals, and thus that general increases in the ability to produce are bound to result in an increase in the supply of the precious metals. 51 It follows that under a system of commodity money the effect of saving—if carried on, on a sufficient scale—is, indirectly, to bring about an increase in the quantity of money. This, of course, is the foundation for a rising aggregate monetary demand—a rising volume of total spending in the economic system—over time. Thus, saving not only does not reduce the total of what is spent in the economic system, but, under commodity money, operates positively and progressively to increase it!

As illustration of this principle, one can take the whole of economic history since the beginning of the Industrial Revolution. The massive capital accumulation and rising productivity of labor of the modern era would have been impossible without the very great increase in the degree of saving and capital intensiveness that took place in comparison with previous eras. A virtually inevitable concomitant of the process, reflecting improvements that thereby became possible in mining, transportation, and engineering, metallurgical, and chemical processes in general was a much more rapid rate of increase in the supply of the precious metals than had previously occurred. Because of its high degree of saving and capital intensiveness, the modern era surpasses previous eras in its ability to increase the supply of precious metals as well as in its ability to increase the supply of goods in general.

Saving as the Source of Rising Consumption

It further follows from the preceding discussions that saving is the source of an increase in consumption, both in real and in monetary terms.

Insofar as more saving means more production of capital goods at the expense of less production of consumers’ goods, the drop in consumers’ goods production

AGGREGATE PRODUCTION AND AGGREGATE SPENDING 699 is strictly temporary. Once the additional supply of capital goods comes into existence, it increases the total ability to produce in the economic system. The result is that the supply of consumers’ goods begins to come back up and the supply of capital goods is further increased. The further increase in the supply of capital goods makes possible a further increase in the supply both of consumers’ goods and capital goods. Soon the production of consumers’ goods surpasses the level it held prior to the shift of factors of production to the production of capital goods, and with each passing year it does so by an ever widening margin. 52

To employ the popular economic analogy of shares of a pie, the smaller is the proportion of the economic pie that is devoted to the production of consumers’ goods and the larger the proportion that is devoted to the production of capital goods, the more rapidly does the total pie grow. The result is that soon, in absolute terms, the smaller consumption share of a growing, or more rapidly growing, economic pie surpasses the larger consumption share of the concomitantly fixed, or less rapidly growing, economic pie.

As an illustration of this principle, one need only consider the post–World War II economic history of Japan. Japan has achieved rapid economic progress in large part by means of devoting a greater proportion of each year’s production to the production of capital goods than almost any other country. The result has been that each year the Japanese economy is able to take advantage of a substantially larger supply of capital goods than the year before and to produce a correspondingly larger output. The larger output is the source both of more consumers’ goods and more capital goods. Because of its low relative production of consumers’ goods and high relative production of capital goods, Japan is today able to consume vastly more in absolute terms than would have been possible otherwise.

What is true in real terms is no less true in monetary terms. The growing quantity of precious metal money that general increases in the ability to produce make possible soon increase the total ability to spend to the point that the smaller proportion of total spending that is constituted by expenditure for consumers’ goods comes to surpass in absolute terms the larger proportion previously devoted to expenditure for consumers’ goods. This phenomenon, of course, is reinforced by the fact that countries whose economies grow relative to the world average attract a growing proportion of the world’s money supply. 53 In today’s monetary conditions, Japan’s rapidly growing increase in ability to produce is responsible for the fact that consumption expenditure in the Japanese paper currency now represents enormously more than it used to, both in real terms and as a fraction of total consumption expenditure in the world economy.

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As a final point in connection with the relationship between consumption and saving, it should be explicitly understood that insofar as what is saved is used to pay wages, there is little or no drop in consumption spending even temporarily. For the wage earners use the far greater part of their wages to consume. Closely related to this point is the fact that most saving by wage earners is used to finance the purchase of expensive consumers’ goods, such as houses or automobiles, or at least has its counterpart in the use of savings for this purpose. To this extent, as I say, saving does not represent a drop in consumption spending even temporarily. Of course, to this extent, saving also does not operate to bring about any progressive increase in production and the quantity of money, either. These results occur only insofar as saving brings about an increase in the relative production of capital goods and decrease in the relative production of consumers’ goods. This occurs primarily, as we shall see, to the extent that businessmen and capitalists reduce the proportion of their sales revenues that they consume and increase the proportion that they save and productively expend.

3. Aggregate Economic Accounting on an

Aristotelian Base

The purpose of this section is to reconcile national income accounting with the Aristotelian proposition that the demand for A is the demand for A, and with the consequent further proposition that most spending in the economic system is productive expenditure, not consumption expenditure. This is essential in that contemporary national income accounting gives every appearance of supporting the opposite and totally wrong conclusions that consumption spending, besides purchasing consumers’ goods, pays most of the incomes in the economic system and is far and away the main form of spending. This section will demonstrate that when properly understood, national income accounting fully confirms the propositions I have advanced.

The central accounting relationship recognized by contemporary economics is that national income—consisting of the sum of all profit, interest, wage, and rental incomes—equals the sum of consumption spending plus net investment, which last sum is called the net national product (NNP). Symbolically, p + w + i + r = Y = NNP = C + I, where p = profits, w = wages, i = interest income, r = rental income, Y = national income, C = total consumption spending, and I = net investment.

700 CAPITALISM

According to contemporary economics, when depreciation allowances are added to the aggregate profit component of national income, profits are raised to gross profits and national income is raised to gross national income. When the same depreciation allowances are added to net investment, net investment is raised to “gross” investment, consisting of spending for plant and equipment plus, be it noted, the net change in business inventories. At the same time, NNP is raised to GNP. 54

The reason that the addition of depreciation allowances to net investment has the above result follows from the nature of net investment. Net investment is the sum of net investment in plant and equipment plus net investment in inventories. Net investment in plant and equipment is equal to expenditure to purchase plant and equipment minus depreciation allowances. Thus, when depreciation allowances are added back in, net investment in plant and equipment is raised to gross investment in plant and equipment, i.e., to expenditure for plant and equipment. However, it is a curious and highly misleading use of terms to call the sum of gross investment in plant and equipment plus the net investment in inventories “gross investment.” It is part and parcel of the misidentification of gross national product as the final product, which, of course, is nothing more than the net national product. In other words, it is an instance of the pervasive confusion on the part of contemporary economics between gross and net. As I will show, a true gross investment figure would require the further addition of cost of goods sold, which would raise net investment in inventories to productive expenditure on account of inventory. 55 As matters stand, gross national product is explicitly presented as the sum of consumption expenditure plus a gross investment that is actually net investment as far as inventories are concerned.

The Consumption Illusion of Contemporary

National-Income Accounting

The misconceptions of contemporary economics concerning the nature of what is produced and what is purchased both profoundly influence and, in turn, are greatly reinforced by contemporary national income accounting. The equality between national income, on the one side, and consumption plus net investment, i.e., net national product, on the other, is interpreted to mean that consumption and net investment pay the national income. And because consumption spending is several times larger than net or even gross investment, contemporary economics assumes that consumption spending pays the far greater part of national income and constitutes the far greater part of spending for goods and services in the economic system. This view is present in every depiction of national income as being determined

Figure 15–2

The “Keynesian Cross”

Y = Y

Y, C, I

E /

- C + I

-

-

C / - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - C

E

C + I

C

45 o

0 Y by the sum of consumption plus net investment. It is blatantly obvious in the socalled Keynesian-cross diagram of Figure 15–2, which is an integral part of every contemporary macroeconomics textbook and is faithfully reproduced there. 56

According to this diagram, consumption pays an amount of income equal to E, if net investment does not exist at all. Given the existence of net investment, which is depicted as the vertical distance between the C and the C + I lines, consumption is held to pay an amount of income equal to E ′ minus I. By following the dashed lines down from E ′ to the C + I line and then across to the vertical axis, one can see that this amount of consumption is supposedly equal to C ′ .

As we have seen, of course, the actual fact is that most spending and income payments are constituted by productive expenditure, not consumption expenditure. The equality between national income, on the one side, and consumption plus net investment, on the other, represents an optical illusion, as it were, insofar as it leads to the conclusion that consumption is the major item of spending and pays most of the incomes in the economic system. Actually, most of the spending and income payments in the economic system are concealed under net investment, which, in effect, is the visible portion of an iceberg. For net investment, as we shall see, is the difference between total productive expenditure in the economic system and aggregate business costs—that, is, the aggregate of the costs that business firms deduct from

AGGREGATE PRODUCTION AND AGGREGATE SPENDING 701 their sales revenues in calculating their profits.

All this becomes obvious if we take the trouble to go through a step-by-step derivation of the equality of national income with consumption plus net investment. I begin with a simplified definition of national income as the sum of profits plus wages. (I count interest income and all genuine “net rental incomes of persons” under the heading of profits. I do so not only for the sake of simplicity, but also because of their actual economic nature. 57 )

Thus, we have, by definition,

(1) p + w = Y, where p = profit, w = wages, and Y = national income.

We also have, by the common accounting definition of profit,

(2) p = s − d, where s = aggregate business sales revenues, and d = aggregate business costs deducted from sales revenues in calculating profits.

It follows that by substituting (2) into (1), we obtain (3) s − d + w = Y.

At this point I divide sales revenues and wage payments from the perspective of the purpose of the parties paying the sales revenues or wages, that is, from the perspective of whether the expenditures are made for the purpose of making subsequent sales or not for the purpose of making subsequent sales. My procedure is strictly in accordance with the concepts I developed earlier, in Chapter 11. 58 Thus, we now obtain

(4) s = s c + s b and

(5) w = w c + w b , where s c = that part of total business sales revenues paid by consumers, i.e., paid not for the purpose of making subsequent sales; s b = that part of total business sales revenues paid by business firms, i.e., paid for the purpose of making subsequent sales; w c = that part of total wages paid by consumers, i.e., paid not for the purpose of making subsequent sales; and w b = that part of total wages paid by business, i.e., paid for the purpose of making subsequent sales. 59

I must stress that s c , s b , w c , and w b represent revenue-expenditure subcomponents of national income and net national product in that they simultaneously represent revenue or income, when viewed from the perspective of sellers, and expenditure, when viewed from the perspective of buyers.

Now, by substituting equations (4) and (5) into equation (3), we obtain

(6) s c + s b − d + w c + w b = Y.

The verbal meaning of equation (6) is that national income is equal to the sum of the part of business sales revenues constituted by consumption expenditure plus the part of business sales revenues constituted by productive expenditure, minus business costs, plus the sum of the part of wages constituted by consumption expenditure plus the part of wages constituted by productive expenditure—that is, that national income is still equal to the sum of profits plus wages, but expressed now in terms of their revenue-expenditure subcomponents.

It further follows that by a change in the order of addition of the revenue-expenditure subcomponents, we obtain

(7) s c + w c + s b + w b − d = Y.

Now, one should realize that

(8) s c + w c = C, that is, that consumption expenditure for goods and services purchased from business firms plus consumption expenditure in payment of wages equals total consumption expenditure constituting revenue or income.

In addition, one should realize that

(9) s b + w b = B, that is, that productive expenditure for goods and services purchased from business firms plus productive expenditure in payment of wages equals total productive expenditure constituting revenue or income.

By substituting equations (8) and (9) into equation (7), it follows that

(10) C + B − d = Y.

Essentially all that remains is to realize that

(11) B − d = I, for reasons to be explained shortly.

Thus, finally, by substituting equation (11) into equation (10), we see that

(12) C + I = Y.

Consequently, we see that the equality between national income and net national product turns out to be a mathematical identity, in which the only difference is a change in the order of addition of identical terms, namely, the revenue-expenditure subcomponents and aggregate business costs.

The full statement of the relationship between national income and net national product is

(13) Y = p + w = (s c + s b − d) + (w c + w b ) =

(s c + w c ) + (s b + w b − d) = C + B − d = C + I= NNP.

The first formulation is national income in terms of its income components, profits and wages; the next formulation is national income in terms of its revenue-expen—

diture subcomponents; then, by a rearrangement of the order of addition, net national product in terms of its revenue-expenditure subcomponents; then net national product in terms of its expenditure components, namely, consumption expenditure plus productive expenditure minus business costs; and finally, net national product stated as the sum of consumption plus net investment. 60 i. Net Investment as Productive Expenditure

Minus Business Costs

I now must show why productive expenditure minus business costs—the same costs as are deducted from sales revenues in calculating profits—equals net investment. This, of course, is the demonstration of equation (11) above—namely, B − d = I.

For the benefit of readers with no background in business accounting, I offer as helpful adjuncts the essential elements both of a business balance sheet and of a business income statement. The balance sheet appears as Figure 15–3, and the income statement as Figure 15–4. In the balance sheet, our focus will be on the “Inventory and Work in Progress” account and on the three fixed-asset accounts “Gross Plant and Equipment and Other Fixed Assets,” “Accumulated Depreciation Reserve,” and “Net Plant and Equipment and Other Fixed Assets.” (For the sake of brevity, I will often refer just to plant and equipment, though it should be realized that everything that applies to their accounting treatment applies to the accounting treatment of other types of fixed assets as well, such as office buildings, warehouses, and pipelines.) In the income statement, our focus will be primarily on the two cost elements “Depreciation” and “Cost of Goods Sold.”

The reason that productive expenditure minus business costs equals net investment is that productive expenditure (viewed from the perspective of those making the productive expenditures) represents debits or pluses to the above asset accounts in the balance sheets of business firms, while business costs represent credits or minuses to those asset accounts. The difference between the sum of the pluses and the minuses is the net change in the asset values of business firms. This net change in the balance-sheet value—the socalled book value—of business assets is net investment.

Productive expenditure embraces the outlays for plant and equipment and all other fixed assets by business. It also embraces the outlays for materials, components, and supplies by business—viz., all the items entering into work in progress or inventories. These outlays represent both purchases of capital goods and wage payments. The outlays for machinery, materials and other capital goods can probably be readily understood as representing additions to asset accounts. But wage payments too are included in the items debited to asset accounts. For example, the wages of construction workers come under the heading of productive expenditure on account of plant and equipment and are debited to the gross plant and equipment account. The wages of direct manufacturing labor come under the heading of productive expenditure on account of work in progress or inventories and are debited to the inventory and work in progress account.

These productive expenditures are related to the costs of production incurred by business firms, but they do not show up directly and immediately as costs of production. Instead, as I have just indicated, they are capitalized— that is, debited to the plant and equipment or inventory and work in progress accounts. Only later, as the plant and equipment or other fixed assets that have been purchased depreciate, and when the inventories that have been purchased or that result from work in progress are sold, do these productive expenditures show up as costs of production in business income statements, where they are deducted from sales revenues in arriving at profits. And at that time, the costs, in the form of depreciation and cost of goods sold, represent a decapitalization of assets—that is, they are deducted from the plant and equipment or inventory and work in progress accounts.

The relationships can be illustrated at the level of an individual company. Thus, for example, if a company spends $10 million to construct a new factory, which will last 50 years, it certainly does not deduct that $10 million from its current year’s sales revenues. Instead, the sum is capitalized, in the form of being added to its gross plant and equipment account. Depending on the particular depreciation method employed, the $10 million acquisition cost of the factory may very well show up as an annual depreciation cost of $200,000 for each of the next 50 years. And as the depreciation costs are incurred, the net value of the factory on the company’s books undergoes a corresponding diminution. While its acquisition value of $10 million stays on the company’s books under the heading gross plant and equipment so long as the factory is owned, each passing year is accompanied by a $200,000 increase in the accumulated depreciation reserve against the factory. Thus, each year the value shown for the factory under the heading net plant and equipment declines by $200,000. If the firm had no other purchases of plant and equipment, it would show a net investment of $10 million in the period in which the factory was being constructed, and thereafter a net disinvestment of $200,000 a year. The principle is that the outlay is capitalized—added to assets—and the depreciation cost corresponding to the outlay represents decapitalization—a subtraction from assets.

Exactly the same principle applies to inventory and

Figure 15–3

The Elements of the Balance Sheet

ASSETS LIABILITIES

Cash

Borrowed Capital

Gross Plant and Equipment and Other Fixed Assets less: Accumulated Depreciation Reserve

Net Plant and Equipment and Other Fixed Assets Equity Capital

Inventory and Work in Progress work in progress. For example, if an automobile com-billion. In other words, the $1 billion of cost of goods pany spends $1 billion in November or December to sold in the company’s income statement will correspond produce automobiles that it will not sell until January or to a disinvestment of a $1 billion in its inventory and February of the following year, its outlay of $1 billion work in progress account. does not show up in its costs deducted from sales reve-Once again, the sequence is: productive expenditure, nues in the current year. Instead, the outlay is capitalized capitalization of productive expenditure in asset account, in its inventory or work in progress account, which is decapitalization of asset account, cost in income state-increased by that amount. Only next year, when the ment.

resulting automobiles are sold, will the $1 billion show It should be obvious that to whatever extent any up as a cost deducted from sales revenues. It will show company makes productive expenditures for plant and up under the heading “cost of goods sold.” And when the equipment or other fixed assets that are greater than the automobiles are sold, the inventory and work in progress depreciation cost it incurs in the same period of time, it account of the automobile company is decreased by $1 experiences a corresponding increase in the value of its

Figure 15–4

The Elements of the Income Statement

Sales

Costs

Depreciation

Cost of Goods Sold

Selling, General, and Administrative Expenses

Net Profit Before Taxes

plant and equipment account net of accumulated depreciation. For it has capitalized a larger sum under the heading of gross plant and equipment than it has decapitalized under the heading of accumulated depreciation reserve. To state the matter in slightly different words: The sum of all of a company’s outlays past and present for the plant and equipment that is still in its possession is its gross plant and equipment account. When the total of accumulated depreciation on all of those assets is subtracted from the gross plant and equipment account, the result is the net plant and equipment account. To the extent that in any given year a company makes productive expenditures for plant and equipment in excess of that year’s depreciation charges, it adds more to the value of its gross plant and equipment account than it adds to the accumulated depreciation reserve that is deducted from that account. Thus, the value of its net plant and equipment account increases to precisely the same extent. This increase in the value of the net plant and equipment account is, of course, net investment in plant and equipment.

In just the same way, to whatever extent any company makes productive expenditures on account of inventories or work in progress that exceed the cost of goods sold it incurs over the same period of time, it must have a corresponding net investment in inventory/work in progress. This is because its productive expenditures for inventory or work in progress will have added to this account a larger sum than its cost of goods sold has subtracted from it, and thus it will have an increase in the book value of its inventory/work in progress account.

It should be realized that implicit in the preceding discussion is the fact that net investment need not always be positive. It can be a negative number. This will be the case if current outlays for plant and equipment are less than current depreciation charges, or if current outlays for inventory or work in progress are less than cost of goods sold. Such conditions exist in the descent into a depression, when productive expenditure sharply declines, while costs, especially depreciation, fall to a much lesser extent, owing to their determination by productive expenditures of the past.

Now productive expenditures on account of plant and equipment and other fixed assets, and on account of inventory and work in progress, do not account for all of productive expenditure, nor do depreciation and cost of goods sold account for all of business costs. There are expenditures firms make in buying from other firms and in paying wages, which are expensed—that is, not debited to physical assets, but deducted as they are made, from sales receipts. Expenditures are expensed, as a rule, when they do not directly contribute to the buying firm’s acquisition of tangible goods. This is the situation, for example, with respect to the salaries of sales and clerical help, advertising outlays, and lighting and heating bills. Such expenditures can be taken as coinciding with the cost category “Selling, General, and Administrative Expenses” in the income statement of Figure 15–4.

These expensed expenditures constitute the remainder of business costs that are subtracted from sales revenues in arriving at the income-statement item “Net Profit Before Taxes.” Thus, total business costs equal depreciation plus cost of goods sold plus expensed expenditures. However, because, by definition, expensed expenditures are costs which are identical with the productive expenditures constituting them, they can be added both to the sum of productive expenditures for the various fixed assets and for inventory and work in progress, and to the sum of depreciation plus cost of goods sold, without in any way affecting the difference between these magnitudes. It is a question of adding equals to unequals, which leaves the amount of the inequality unaffected. When added to the productive expenditures for the various fixed assets and for inventory/work in progress, they result in total productive expenditures constituting revenue or income to sellers. When added to depreciation plus cost of goods sold, they result in total business costs. Net investment is thus the difference between such productive spending and the business costs deducted from business sales revenues in computing profits, which is what I set out to prove.

The preceding discussion can be summarized in the form of the matrix shown as Table 15–2. In the table, productive expenditure, which equals the sum of s b + w b and is represented by B, is broken down into B 1 + B 2 + B 3 , where B 1 = productive expenditure on account of plant and equipment, B 2 = productive expenditure on account of inventory, and B 3 = productive expenditure that is expensed, i.e., written off as made. (For the sake of brevity, I have omitted reference both to “other fixed assets” in connection with plant and equipment and to “work in progress” in connection with inventory, and will hereafter continue this practice.) In exactly the same way, aggregate business costs d are broken down into d 1 , d 2 , and d 3 , where d 1 = depreciation cost, d 2 = cost of goods sold, and d 3 = cost constituted by productive expenditure that is expensed. In the table, I represents total net investment, while I 1 is net investment in plant and equipment, and I 2 is net investment in inventory.

Table 15–2 shows that when all costs together— namely, d—are subtracted from the totality of productive expenditure, B, the result is total net investment, I. It shows at the same time that when depreciation cost, d 1 , is subtracted from productive expenditure on account of plant and equipment, namely, B 1 , the result is net investment in plant and equipment, I 1 . At the same time, it

Table 15–2

Productive Expenditure Minus Costs Equals Net Investment

B = B 1 + B 2 + B 3

– d = – d 1 + – d 2 + – d 3

I = I 1 + I 2 + 0 shows that when cost of goods sold, d 2 , is subtracted from productive expenditure on account of inventory, B 2 , the result is net investment in inventory, I 2 . Finally, the table shows that when costs constituted by productive expenditures that are expensed, d 3 , are subtracted from those same productive expenditures, B 3 , the result is zero, inasmuch as the two magnitudes are identical. Thus, the table shows simultaneously that net investment is productive expenditure minus costs and is equal to net investment in plant and equipment plus net investment in inventory, both of which in turn are equal to specific categories of productive expenditure minus specific categories of cost.

---

Table 15–2 makes it possible to relate the analysis I have presented, to contemporary national income accounting. We have seen that in contemporary national income accounting, net investment is defined as gross investment minus depreciation, and that gross investment itself is defined as gross plant and equipment expenditure plus the net change in inventories. The analysis I have presented can be understood in terms of a concept of gross investment that is larger than that which is usually called gross investment. Call it gross gross (double gross) investment. Gross gross investment is the entire expenditure that firms make for tangible goods obtained from other firms and for labor that they directly employ in the production of tangible goods. It is gross plant and equipment expenditure plus actual, gross expenditure for inventory—in terms of Table 15–2, it is B 1 + B 2 . Subtract from this amount “cost of goods sold,” and one has what is usually called gross investment, for gross expenditure for inventory less cost of goods sold is the net inventory change. Net investment, obviously, is the difference between gross gross investment and depreciation plus cost of goods sold.

The addition of expensed productive expenditures to gross gross investment, of course, raises the latter to productive expenditure. Starting with productive expenditure, productive expenditure minus expensed expenditures equals gross gross investment expenditure. Gross gross investment expenditure minus cost of goods sold equals gross investment. Gross investment minus depreciation equals net investment. All of this adds up to the fact that productive expenditure minus business costs equals net investment. At the same time, it helps to point the way to the integration of national income accounting with the wider, Aristotelian and classical-economics-based accounting framework of my own.

ii. Net Investment as the Tip of the Productive

Expenditure Iceberg

Now that the relationship between net investment and productive expenditure has been made clear, it is possible to understand how contemporary national income accounting completely misinterprets the equality between national income and net national product. Table 15–3 provides an arithmetical example that clearly illustrates the illusion of viewing consumption spending as the main source of revenue and income payments in the economic system.

The table assumes the existence of a national income/net national product of 600 monetary units. This amount appears in the second row of the center column of the table, under the heading Y/NNP. The 600 is respectively equal both to a sum of 150 of profit income plus 450 of wage income, shown on the left-hand side of the table, and to a sum of 550 of consumption expenditure plus 50 of net investment, shown on the righthand side of the table. Like the 600 of national income/net national product, these magnitudes are shown in the second row of the table, under the respective column headings for the various magnitudes, which occupy the first row of the table. (It should be observed that the table’s relative breakdown of national income between profit and wages, and of net national product between consumption expenditure and net investment, approximates the actual data found in a typical year.)

In the third row, the table states the profit and wage components of national income, and the consumption and net-investment components of net national product, in terms of their identical but differently ordered revenue-expenditure subcomponents. These revenue-expenditure subcomponents, of course, were explained earlier

Table 15–3

The Optical Illusion of Consumption as the Main Form of Spending

(1) p + w = Y/NNP = C + I

(2) 150 + 450 =

(3) (s c + s b – d) + (w c + w b ) =

(4) (500+500–850) + (50+400) = in this section, in my derivation of the equality between national income and net national product. I use the same algebraic notation in the table as I did in that derivation.

In the fourth row of the table, I supply specific quantitative values for each of the revenue-expenditure subcomponents. Thus I assume that the 150 of profit income is the result of the existence of 1,000 of aggregate business sales revenues, less 850 of aggregate business costs. I further assume that the sales revenues are constituted by 500 of consumption expenditure, s c , plus 500 of productive expenditure, s b . I also assume that the 450 of wages are constituted by 50 of wages paid by consumers, w c , plus 400 of wages paid by business firms, w b . On the basis of previous discussion, I believe I am entitled to say that the assumed relative values of productive expenditure and consumption expenditure are in accordance with the actual facts.

It is obvious from the table that total expenditure and total revenue and income payments in the economic system are not the national income/net national product figure of 600, or even a gross national product figure of the 600 plus depreciation charges, but 1450. That is, it is the sum of product sales revenues of 1,000 plus 450 of wage payments. It is also obvious that the portion of total revenue and income payments constituted by consumption expenditure is a mere 550 out of this 1450 (i.e., 500s c + 50w c ), while the portion of total revenue and income payments constituted by productive expenditure is 900 (i.e., 500s b + 400w b ).

Indeed, things are virtually the opposite of what contemporary, Keynesian economics believes in connection with the relative quantitative significance of consumption expenditure. Instead of consumption expenditure constituting 11 ⁄ 12 ( 550 ⁄ 600 ) of aggregate spending and paying 11 ⁄ 12 of national income, while net investment constitutes and pays only 1 ⁄ 12 ( 50 ⁄ 600 ), the truth is that

600 = 550 + 50

Y = (s c + w c ) + (s b + w b – d)

600 = (500+50) + (500+400–850)

consumption expenditure constitutes only 550 out of 1450 of total spending and pays only a mere 50 of income out of 600 of income. By the same token, productive expenditure, concealed under the head of net investment, constitutes 900 out of 1450 of total spending, and pays 400 out of the 600 of national income. (Productive expenditure pays 400 out of the 450 of total wage income. The 150 of profit income is not literally “paid” by any expenditure. Five hundred of productive expenditure and 500 of consumption expenditure pay 1,000 of sales revenues, on which 150 of profit income is earned. Accordingly, one might attribute 75 of profit income to productive expenditure and 75 to consumption expenditure. This procedure would make productive expenditure responsible for 475 of national income, and consumption expenditure responsible for 125.)

What conceals the enormous role of productive expenditure in today’s national income accounts is that its presence is only implicit, in the form of net investment. Net investment, of course, is productive expenditure minus a magnitude that necessarily is always at least almost as large, namely, aggregate business costs. Thus, it is only a modest residual of productive expenditure that manages to come through in today’s accounts, thereby creating the impression that most spending and income payments take place in the form of consumption expenditure. This is why, insofar as sources of spending are concerned, I have described net investment as the tip of the productive expenditure iceberg.

Gross National Revenue

The preceding discussion shows that if one wants to make the national income accounts consistent with sound economic analysis and a proper recognition of the role of saving and productive expenditure in spending and income payments, a fundamental change in procedure is required. What I suggest is taking a new, much larger

Table 15–4

From Gross National Revenue to National Income and Net National Product s + w = GNR = C + B

– d = – d = – d p + w = Y/NNP = C + I figure than gross national product as the conceptual starting point—namely, the sum of all revenue and income payments in the economic system. This total, gross national revenue (GNR), would consist of the sum of business sales revenues s plus wage incomes w, on the one side, and the sum of the consumption expenditure, C, plus the productive expenditure, B, that pays those revenues and incomes, on the other side. This is shown in the following equation:

s + w = GNR = C + B

Table 15–4 shows how it is possible to begin with this equation and then go directly to national income, on the left, and to net national product, on the right, by subtracting aggregate business costs d. On the left, d is subtracted from s, which results in aggregate profit p, and which reduces the sum of sales revenues plus wages, which is gross national revenue, to the sum of profits plus wages, which is national income. On the right, d is subtracted from productive expenditure, which results in net investment, I, and which reduces the sum of consumption expenditure plus productive expenditure (also equal to gross national revenue) to the sum of consumption expenditure plus net investment.

It should be noted that if, in this procedure, one subtracts all costs but depreciation cost, one arrives at the contemporary concept of GNP. That is, one has profit gross of depreciation on the left, and “gross” investment—i.e., plant and equipment spending plus the net investment in inventories—on the right. (One could, of course, introduce all of the intermediate steps described earlier in going from productive expenditure to net investment.)

More on the Critique of the Multiplier

The gross-national-revenue framework provides an excellent vehicle for illustrating in precise quantitative terms what is wrong with the Keynesian multiplier doctrine. That doctrine, it should be recalled, claims that a given increase in “investment” brings about a series of further increases in consumption, thereby resulting in an increase in national income that is a multiple of the original increase in investment. For example, with a “marginal propensity to consume” (viz., fraction of additional income consumed at each round) of .75, 10 of additional net investment is supposed to result in 30 of additional consumption and thus 40 of additional national income. 61

Now the gross-national-revenue framework necessary for the analysis of the multiplier has already been presented in Table 15–3, “The Optical Illusion of Consumption as the Main Form of Spending.” Table 15–3 is reproduced in Table 15–5, titled “The ‘Multiplier’ in the GNR Framework.” In Table 15–5 two new rows have been added to those of the earlier table. The first of these new rows, Row 3, shows the alleged operation of the multiplier in the superficial terms in which the Keynesians propound it, that is, in terms merely of net investment and consumption. Thus, in the rightmost column, the table shows net investment increased by 10, that is, to 60 from the 50 of the second row. One column to the left, it also shows consumption increased by 30, that is, from the 550 of the second row to the 580 of the third row. On this basis, in the center column, the table dutifully shows national income and net national product increased from 600 to 640. Unlike the Keynesians, however, Row 3 shows on its left-hand side that the 40 of additional net national product and national income takes place specifically in the form of 40 of additional profit income and no additional wage income. This is a result that the highly superficial analysis of the Keynesians is unaware of and incapable of realizing. For the ability to recognize it depends on the use of the gross-national-revenue framework, which appears in the next three rows of the table.

Of those next three rows, the first two, that is, Rows 4 and 5, are reproduced exactly from Table 15–3. Only the last, Row 6 in the table, is new. It shows, in the rightmost column, that 10 of additional net investment comes about by virtue of 10 of additional s b , which rises

Table 15–5

The “Multiplier” in the GNR Framework

(1) p + w = Y/NNP = C + I

(2) 150 + 450 =

(3) 190 + 450 =

(4) (s c + s b – d) + (w c + w b ) =

(5) (500+500–850) + (50+400) =

(6) (530+510–850) + (50+400) = from 500 in Row 5 of the table to 510 in Row 6. In raising total productive expenditure by 10, in the face of an unchanged magnitude of aggregate business costs, it results in 10 more of net investment. To be precise, total productive expenditure is elevated from the sum of 500 of s b plus 400 of w b , namely 900, to 510 of s b plus, once again, 400 of w b , namely to 910. In the face of the same aggregate business costs, d, of 850, the result is a rise in net investment from 50 to 60.

At the same time, of course, inasmuch as s b is not only a component of productive expenditure but also of business sales revenues, its new value of 510 must appear as sales revenues on the left-hand side of the Row 6. There its effect is to raise total sales revenues from 1,000, which is the sum of 500 of s c plus 500 of s b , to 1,010, which is the sum of 500 of s c plus, this time, 510 of s b . In the face of the same aggregate business costs, d, of 850, the result is a rise in aggregate profit from the 150 of Rows 2 and 5 to 160.

The rise in profits that is shown in Rows 3 and 6 is in fact much greater, namely, to 190 from 150. This is the result of the 30 of additional consumption spending that the multiplier doctrine alleges to occur on the basis of the 10 of additional net investment. The 30 of additional consumption spending constitutes 30 of additional business sales revenues, or at least something very close to 30 of additional business sales revenues. This is because the far greater part of private consumption spending is for goods and services of business firms, not for the labor of wage earners. For all practical purposes any additional demand for domestic servants can simply be disregarded.

Thus, on the righthand side of Row 6, I show the rise in consumption as taking place entirely as a rise in s c from 500 to 530, which has the effect of raising total

600 = 550 + 50

640 = 580 + 60

Y = (s c + w c ) + (s b + w b – d)

600 = (500+50) + (500+400–850)

640 = (530+50) + (510+400–850)

consumption from the sum of 500 of s c plus 50 of w c to 530 of s c plus 50 of w c , namely, from 550 to 580 of total consumption, C. At the same time, on the left-hand side of Row 6, the effect of the additional consumption is 30 more of business sales revenues and thus 30 more of aggregate profit. For business sales revenues are further increased from the sum of 500 of s c plus 510 of s b , to the sum of 530 of s c plus 510 of s b , that is, from 1,010 to 1,040. And because aggregate costs, d, remain at 850, the effect, as shown explicitly in Row 2 of the table, is to increase profits from 150 to 190.

It cannot be stressed too strongly that, consistent with the law of identity and the entire preceding discussion of this chapter, there is in this whole process absolutely no increase in the demand for labor by business or any further increase in the demand for capital goods subsequent to the initial 10 that gave rise to the increased net investment of 10. Furthermore, it should be realized that nothing essential is changed if we drop the assumption that all of the additional net investment is caused by a rise in s b and assume instead that some of it results from additional w b . If for example, 5 of the initial 10 of net investment had come about in this way, once again followed by 30 of additional consumption, the only effect would have been that the rise in profits, instead of being all 40 of the rise in national income, would have been 35, and the rise in wages, instead of being zero, would have been 5. (That is, the rise in wages would have been the wages that might have been contained in the one possible act of productive expenditure present.) Contrary to the multiplier doctrine, any rise in the demand for labor or capital goods depends—it must be said once again—on what is not consumed, but saved and productively expended.

4. Importance of Recognizing the Separate Demand for Capital Goods for the Theory of Capital Accumulation and the Theory of National Income

This chapter’s stress on the fact that the demand for A is the demand for A and thus that the demand for capital goods and the demand for labor are separate and distinct from the demand for consumers’ goods was the implicit basis of the theory of capital accumulation that I presented in Chapter 14. 62 It was only by virtue of my having recognized the separate existence of the demand for capital goods, and the separate, distinct production of capital goods, that I was able to realize that capital goods are used to produce capital goods no less than consumers’ goods. It was this, in turn, that led me to realize that once additional capital goods are brought into existence on the basis of a rise in saving, those additional capital goods themselves make possible a further increase in the supply of capital goods, through their contribution to the increase in production. It is impossible to make these connections if one believes that all that is produced are consumers’ goods. In that case, one believes that additional capital goods are brought into existence exclusively by means of saving. This is because the additional capital goods brought into existence by saving are held to be a source only of additional consumers’ goods. To have a further increase in the supply of capital goods, further saving is thought to be necessary.

Thus, the failure to recognize the separate existence of the demand for capital goods and the corresponding separate production of capital goods prevents the development of a sound theory of capital accumulation. However ironic, it leads both to an inadequate appreciation of the role of saving in capital accumulation and to a corresponding overemphasis on the role of saving in capital accumulation. It leads to a failure to see that fundamentally saving is to capital accumulation as force is to acceleration. That is, it leads to a failure to see that a given increase in saving and in the relative demand for capital goods can be the cause of continuing capital accumulation, while a further increase in saving and the relative demand for capital goods serves to bring about an acceleration in the rate of capital accumulation. 63 The failure to recognize the separate existence of the demand for capital goods and the corresponding separate production of capital goods also prevents recognition of the role of technological progress as a cause of capital accumulation in serving to maintain the productivity of the increasing supply of capital goods. In addition, of course, it prevents recognition of all other causes serving to increase production in general as thereby being sources of capital accumulation. In effect, if one does not heed the fact that capital goods as well as consumers’ goods are produced, one must be oblivious to almost everything that contributes to their supply.

My purpose here in recalling the theory of capital accumulation I presented in Chapter 14 is not only to show its implicit dependence on the recognition of the separate, distinct demand for capital goods and the separate, distinct production of capital goods. It is also to begin to show how when that analysis of capital accumulation is combined with the explicit recognition of separate, distinct demands for capital goods and labor as well as consumers’ goods, it serves to provide a conceptual framework for the analysis of numerous other major questions in economics, including, above all, the determinants of aggregate profit and the average rate of profit in the economic system.

My analysis of the determinants of the rate of profit is reserved for the next chapter. Here, however, as a preliminary to that analysis, by means of providing further knowledge in connection with aggregate economic accounting and the determination of national income, I must ask the reader to consider Figures 15–5 and 15–6. These are elaborated versions of Figures 14–4 and 14–5, respectively, which were essential vehicles for conveying my analysis of the role of saving and the relative demand for capital goods in capital accumulation. 64 Figures 15–5 and 15–6 take the essential information supplied in Figures 14–4 and 14–5 concerning the role played by the relative demands for capital goods and consumers’ goods in the context of an invariable money and show how those two figures respectively imply definite amounts of national income.

If we examine Figure 15–5, we see that in representing the demand for capital goods as 500 units of money and the demand for consumers’ goods as a further 500 units of money, Figure 14–4 implies that total sales revenues in the economic system are 1,000 units of money. This is because total sales revenues in the economic system are nothing but the sum of the receipts from the sale of capital goods plus the receipts from the sale of consumers’ goods, which, of course, as Figure 15–5 shows, are precisely equal to the expenditures made in buying capital goods and consumers’ goods. (From the perspective of the buyers, every dollar of sales revenue is an expenditure that is made either for the purpose of making subsequent sales or not for the purpose of making subsequent sales. In the first case, it constitutes receipts from the sale of capital goods; in the second, receipts from the sale of consumers’ goods. 65 ) A total of 1,000 of such expenditures means a total of 1,000 of sales receipts.

Furthermore, under the assumptions on which Figure 14–4 was constructed, and which, of course, apply to Figure 15–5, it follows that the demand for capital goods of 500 in each year can be taken as a cost of producing

Figure 15–5

Formation of National Income in a Stationary Economy with an Invariable Money

Year 1 i1 K OF CAPITAL GOODS

PLUS 1L OF LABOR

PRODUCE:

50% mmmmm50%

Year 2 i1K OF CAPITAL GOODS i1C OF CONSUMERS’ GOODS In Response to 500 of Demand for Capital In Response to 500 of Demand for Consumers’ Goods. This 500 of demand for capital goods is Goods. This 500 of demand for consumers’ goods is simultaneously 500 of sales revenues to the sellers of the simultaneously 500 of sales revenues to the sellers of the capital goods. It will also result in 500 of cost on account consumers’ goods. of capital goods to the buyers, next year, when they sell the products the capital goods are used to produce.

I1 K OF CAPITAL GOODS, at a cost ofn

500 to their buyers, PLUS 1L OF

LABOR PRODUCE:

50% mmm m50%

Year 3 i1K OF CAPITAL GOODS, at a cost value of i1C OF CONSUMERS’ GOODS, at a cost value

250 on account of the capital goods used to of 250 on account of the capital goods used to produce them (i.e., 50% of 500) produce them (i.e., 50% of 500) In Response to 500 of Demand for Capital In Response to 500 of Demand for Consumers’ Goods. This 500 of demand for capital goods is Goods. This 500 of demand for consumers’ goods is simultaneously 500 of sales revenues to the sellers of the simultaneously 500 of sales revenues to the sellers of the capital goods. It will also result in 500 of cost on account consumers’ goods. of capital goods to the buyers, next year, when they sell the products the capital goods are used to produce.

I1 K OF CAPITAL GOODS, at a cost ofn

500 to their buyers, PLUS 1L OF

LABOR PRODUCE:

---

Year N 50% mmmmm50% i1K OF CAPITAL GOODS, at a cost value of i1C OF CONSUMERS’ GOODS, at a cost value

250 on account of the capital goods used to of 250 on account of the capital goods used to produce them (i.e., 50% of 500) produce them (i.e., 50% of 500) In Response to 500 of Demand for Capital In Response to 500 of Demand for Consumers’ Goods. This 500 of demand for capital goods is Goods. This 500 of demand for consumers’ goods is simultaneously 500 of sales revenues to the sellers of the simultaneously 500 of sales revenues to the sellers of the capital goods. It will also result in 500 of cost on account consumers’ goods. of capital goods to the buyers, next year, when they sell the products the capitial goods are used to produce.

Figure 15–6

Formation of National Income in a Progressing Economy with an Invariable Money

Year 1 i1K OF CAPITAL GOODS

PLUS 1L OF LABOR

PRODUCE:

60% mmmmm40%

Year 2 i1.2K OF CAPITAL GOODSn .8C OF CONSUMERS’ GOODS In Response to 600 of Demand for Capital In Response to 400 of Demand for Consumers’ Goods.This 600 of demand for capital goods is Goods. This 400 of demand for consumers’ goods is simultaneously 600 of sales revenues to the sellers of the simultaneously 400 of sales revenues to the sellers of the capital goods. It will also result in 600 of cost on account consumers’ goods. of capital goods to the buyers, next year, when they sell the products the capital goods are used to produce.

i1.2K OF CAPITAL GOODS, at cost of

600 to their buyers, PLUS 1L OF

LABOR PRODUCE:

60% mmmmm40%

Year 3 i1.44K OF CAPITAL GOODS, at a cost value of i .96C OF CONSUMERS’ GOODS, at a costn

360 on account of the capital goods used to value of 240 on account of the capital goods produce them (i.e., 60% of 600) used to produce them (i.e., 40% of 600) In Response to 600 of Demand for Capital In Response to 400 of Demand for Consumers’ Goods. This 600 of demand for capital goods is Goods. This 400 of demand for consumers’ goods is simultaneously 600 of sales revenues to the sellers of the simultaneously 400 of sales revenues to the sellers of the capital goods. It will also result in 600 of cost on account consumers’ goods. of capital goods to the buyers, next year, when they sell the products the capital goods are used to produce.

i1.44K OF CAPITAL GOODS, at a cost of 600 to their buyers, PLUS 1L OF

LABOR PRODUCE:

60% mmmmm40%

Year 4 i1.728K OF CAPITAL GOODS, at a cost value of i1.152C OF CONSUMERS’ GOODS, at a cost

360 on account of the capital goods used to value of 240 on account of the capital goods produce them (i.e., 60% of 600) used to produce them (i.e., 40% of 600) In Response to 600 of Demand for Capital In Response to 400 of Demand for Consumers’ Goods. This 600 of demand for capital goods is Goods. This 400 of demand for consumers’ goods is simultaneously 600 of sales revenues to the sellers of the simultaneously 400 of sales revenues to the sellers of the capital goods. It will also result in 600 of cost on account consumers’ goods. of capital goods to the buyers, next year, when they sell the products the capital goods are used to produce.

the output of the following year. This is because the capital goods in existence at the beginning of any year are all assumed to be used up or worn out in that very same year in the course of producing the supply of capital goods and consumers’ goods available at the start of the following year. Thus, the 500 of outlays for capital goods in each year are a cost of producing the output of the next year because they are made for no other reason than for the purpose of producing that output and bringing in the sales revenues obtained in exchange for it. Figure 15–5 shows this total cost of 500 on account of capital goods as consisting of 250 of respective separate costs on account of capital goods, for the capital goods and the consumers’ goods of the following year, each of which comes into being as the result of the use of 50 percent of the 500 worth of capital goods and of the labor of the year before.

In sum, Figure 15–5 shows 1,000 of sales revenues in the economic system in every year and 500 of costs on account of capital goods, which costs reflect the outlays to purchase capital goods in the year before. This is so at least starting with Year 3, which is the first year in Figure 15–5 that follows an explicit outlay of money to buy capital goods. Thus, in Figure 15–5, we can observe 1,000 of aggregate sales revenues in the economic system and at least 500 in aggregate costs in the economic system in every year from Year 3 on.

As I have said, this difference between aggregate sales revenues and aggregate costs which are exclusively on account of capital goods, can be taken as representing national income. This follows from the fact that costs exclusively on account of capital goods exclude costs on account of wages. 66 Costs that exclude costs on account of wages are costs minus those wages. Thus, sales revenues minus costs that exclude wages are equal to profit plus those wages, which is to say, for all practical purposes, national income. In terms of a very simple equation, sales revenues – (costs – wages) = profits + wages =

67 national income.

The most important thing to keep in mind about national income is that it is necessarily the counterpart overwhelmingly just of consumer spending. We already know this from our derivation of the equality between national income and net national product, in the previous section of this chapter. It also follows from the fact that national income is sales revenues minus costs on account of capital goods. In Figure 15–5, of course, not only do costs on account of capital goods in any year equal the outlays for capital goods made the year before, but also the outlays remain the same from year to year—always being 500 units of money. As a result, in Figure 15–5, sales revenues minus costs on account of capital goods also equals sales revenues minus the current demand for capital goods, since the current demand for capital goods is equal to the demand of the previous year and thus to the costs on account of capital goods deducted from sales revenues this year. Therefore, in Figure 15–5, national income equals only the remaining sales revenues, which represent the demand for consumers’ goods alone. Indeed, in all circumstances, the national income earned in connection with the sales revenues of any year, can never exceed the consumer spending of that year by very much. The excess can be no more than the amount by which the current demand for capital goods exceeds the costs deducted from sales revenues on account of capital goods. 68

The Inverse Relationship Between National Income and Economic Progress in an Economy With an

Invariable Money

The discussion of capital accumulation in Chapter 14, in particular the role of the demand for capital goods relative to the demand for consumers’ goods, and now the realization that national income is the counterpart of consumption expenditure, imply that national income and economic progress can be inversely related. Economists have long known this to be the case in the context of inflation, in which national income rises merely as the result of rapid increases in the quantity of money and volume of spending, which at the same time undermine capital accumulation. 69 What the present analysis shows is that in the total absence of inflation, indeed, precisely in the context of an invariable money, in which the quantity of money and the aggregate demand for the products of business remain absolutely fixed, national income and economic progress are inversely related.

This conclusion becomes obvious when Figure 15–6 is observed. In Figure 15–6, the demand for capital goods is 600 units of money in each year from Year 2 on, while the demand for consumers’ goods has fallen to 400 units of money. We have already seen how this rise in the demand for capital goods and fall in the demand for consumers’ goods brings about an acceleration in capital accumulation and economic progress from zero—the stationary economy of Figure 15–5—to 20 percent a year. 70 It is only necessary to observe now that national income in Figure 15–6 falls to 400 monetary units from its previous height of 500 monetary units. National income is only 400, and can only be 400, because total sales revenues in the economic system are still only 1,000— the sum of the demand for capital goods of 600 plus the demand for consumers’ goods of 400—while costs on account of capital goods rise to 600. National income falls, because the rise in demand for capital goods increases the costs on account of capital goods which must

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be subtracted from the unchanged total sales revenues. The amount by which sales revenues exceed the costs on account of capital goods, and thereby determine national income, is now only the diminished consumption expenditure of 400 units of money instead of the 500 units of money that it was in Figure 15–5. (As was the case in Figure 15–5, Figure 15–6 breaks down the total cost of capital goods into the separate portions chargeable to the respective production of capital goods and consumers’ goods. Because 60 percent of the 600 worth of capital goods of each year from Year 2 on are used up to produce capital goods for the next year, the cost of those capital goods, on account of capital goods, is calculated as 360. By the same token, the cost of the consumers’ goods, representing the using of up of 40 percent of the 600 worth of capital goods of the year before is calculated as 240.)

The essential findings are shown on a year-by-year basis in Tables 15–6 and 15–7, which correspond to Figures 15–5 and 15–6 respectively. The only difference is that the tables extend the data of the figures out to Year 5. The tables show the demand for capital goods and the demand for consumers’ goods in each year and the total sales revenues generated by the sum of these two demands. The generation of sales revenues is depicted graphically, by short lines drawn down from the respective demands for capital goods and consumers’ goods in each year to a longer line drawn across and culminating in an arrow pointing up to the 1,000 of sales revenues in that year. Downward, rightward sloping arrows show the demand for capital goods in each year as determining the costs on account of capital goods which appear in the following year. National income in each year is shown as the difference between the 1,000 of sales revenues in each year and these costs on account of capital goods.

Thus, the conclusion is evident that, in the context of an invariable money, national income and economic progress are inversely related. Economic progress depends on the demand for capital goods, but the greater is that demand, the greater is the deduction of cost on account of capital goods from sales revenues, and thus the less that remains for national income, given aggregate sales revenues that are fixed.

This conclusion that the fall in national income is the accompaniment of more rapid economic progress must cause bewilderment to people who are accustomed to think of economic wellbeing and rising money income as inseparable. Thus, it is necessary to stress that the improvement in economic wellbeing is still fully present. It merely takes the form of falling prices of products. In an economic system with an invariable money—that is, once again, a fixed quantity of money and a fixed volume of aggregate spending to buy the products of business—a rise in the relative demand for capital goods and the growing supply both of capital goods and consumers’ goods that it causes results in a continuing fall in the prices of capital goods and consumers’ goods. Thus, from one year to the next, the diminished monetary amount of national income has a greater buying power.

If we compare Figures 15–5 and 15–6, we can observe that while national income in Figure 15–6 is only 400, in comparison with the 500 of Figure 15–5, the prices of capital goods and consumers’ goods in Figure 15–6 fall every year, from Year 3 on, in the ratio of 5: 6. This follows from the fact that, starting in Year 3, the same expenditures for capital goods and consumers’ goods of 600 and 400 respectively, buy supplies of capital goods and consumers’ goods that are twenty percent or six-fifths larger than the year before. Six-fifths the supplies,

Table 15–6

National Income in Figure 15-5

Year Demand for Demand for

Capital Goods Consumers’ Goods 1

2 500 500 3 500 500 4 500 500 5 500 500

Sales Costs on Account National Revenues of Capital Goods Income 1,000

1,000 500 500 1,000 500 500 1,000 500 500

divided into unchanged demands, result in prices that are five-sixths as great. In contrast, in Figure 15–5, where national income is 500 rather than 400, and the relative production of capital goods is correspondingly less, there is no increase in the supply of capital goods and consumers’ goods, therefore no fall in the prices of capital goods or consumers’ goods, and thus no increase in the buying power of incomes. In terms of buying power, the 400 of national income of Figure 15–6 further and further surpasses the 500 of national income of Figure 15–5.

Now it should certainly not be concluded from this discussion that there is no connection whatever between increasing production and rising money incomes. As I have pointed out several times before, there in fact is a connection. Under a system of commodity money, such as a gold or silver standard, a growing general ability to produce will almost certainly be reflected in improvements in the ability to extract and refine minerals, including gold and silver, the monetary commodities. Thus an increasing quantity of money and therefore a rising volume of spending and of money incomes will almost inevitably occur as by-products of the increasing ability to produce. The processes of rising money incomes and growing production will therefore be parallel to an important extent, at least under a system of commodity money. But even though parallel, the processes are nevertheless separate and distinct and must always be sharply distinguished in thought. As indicated in Chapter 12, in the discussion in which the concept of invariable money was introduced, just as a physicist or engineer conceives of the motion of objects as determined by a variety of distinct forces acting in combination and analyzes the effects of each one acting separately—for example, the combination of gravitation and air pressure, or the combination of engine power, water current, and wind—so the economist must separately analyze the effects of changes in the relative demand for and production of capital goods and consumers’ goods and the consequent changes in the rate of increase in the production and supply of goods for sale, on the one side, and changes in the quantity of money and volume of spending to buy those goods, on the other. Having done this in analyzing the process of capital accumulation under the assumption of an invariable money, we are able to recognize that, with any given quantity of money and volume of spending for the goods and services of business, the rate of capital accumulation and economic progress is in fact inversely related to the height of national income.

Overthrow of the Keynesian Doctrines of the

Balanced-Budget Multiplier and the

Conservatives’ Dilemma

It should be realized that the recognition of the inverse relationship between nominal national income and economic progress in the context of an invariable money constitutes a substantive overthrow of the Keynesian doctrine of the “balanced-budget multiplier.” That doctrine, which is propounded in almost every contemporary “macroeconomics” textbook, claims that an equal increase in taxes and government spending raises the national income by an equivalent amount—that, for example, if both taxes and government spending are increased by $10 billion, national income will also increase by $10 billion. The Keynesians, of course, assume that such an increase in national income is all to the good, and is on the order of a lesser miracle achieved by government intervention. 71

Table 15-7

National Income in Figure 15-6

Year Demand for Demand for

Capital Goods Consumers’ Goods 1

2 600 400 3 600 400 4 600 400 5 600 400

Sales Costs on Account National Revenues of Capital Goods Income 1,000

1,000 600 400 1,000 600 400 1,000 600 400

What the Keynesians have failed to see in their zeal to overturn common sense is that under the operation of the “balanced-budget multiplier,” national income rises by virtue of a form of consumption—viz., government spending—taking the place of demand for capital goods. To finance the additional government spending, the taxpayers must reduce their saving and expenditure for capital goods. If the fall in expenditure for capital goods finances the whole of the rise in government spending, then, indeed, national income will increase by an equivalent amount. This is because aggregate sales revenues in the economic system will remain the same—with receipts from the sale of consumers’ goods to the government or its clients taking the place of receipts from the sale of capital goods to business—while the costs deducted from sales revenues on account of capital goods will fall. But this result, of course, is accompanied by a corresponding decline in the relative production of capital goods and therefore in economic progress and prosperity. Thus the Keynesians totally misinterpret the significance of the rise in national income that would materialize. What the Keynesians have done here is failed to heed the distinction advanced by Ricardo between “value,” which can be understood as money national income in the context of an invariable money, and “riches,” i.e., real physical wealth. As I have pointed out more than once, and as Ricardo pointed out in the early nineteenth century, the two are separate and distinct and can move in opposite directions.

The recognition of the inverse relationship between nominal national income and economic progress is also a refutation of the alleged conservatives’ dilemma that is founded on the balanced-budget multiplier doctrine. The “conservatives’ dilemma” is the alleged dilemma of having to choose between stimulating the economic system either by means of budget deficits, if one relies on the standard government-spending or tax multipliers propounded by the Keynesians, or by means of an increase in the size of government spending several times greater than what would supposedly be required in connection with a deficit. Thus, for example, it is claimed that with a government-spending multiplier of 4 and a tax multiplier of -3 (both of which allegedly follow from the same “marginal propensity to consume”), national income could be increased by a given amount, such as $10 billion, in either of three ways: by increasing both taxes and government spending by $10 billion and thus maintaining a balanced budget, or by incurring a budget deficit of $2.5 billion brought about through increased government spending with no accompanying increase in taxes or, finally, by incurring a budget deficit of $3.33 billion brought about by tax reduction with no accompanying decrease in government spending. The alleged dilemma represented by such an example is that economic prosperity requires that American conservatives choose between their two cherished principles of balanced budgets and small government. Allegedly, they must accept either deficits with relatively small government or, if they insist on maintaining balanced budgets, much greater growth in government, because one or the other is supposedly necessary for a given increase in national income. 72

What my analysis has shown, both in this section and in my critiques of the multiplier doctrine earlier in this chapter, is that any increase in national income brought about in such ways is inversely related to capital accumulation and economic progress, because it would represent a rise in the relative demand for and production of consumers’ goods at the expense of the relative demand for and production of capital goods. It would also represent a fall in the share of consumption based on wage payments, which, like the demand for capital goods, depends on saving and productive expenditure. National income is simply not the standard of economic prosperity. Any rise in national income accomplished by means of the demand for consumers’ goods rising at the expense of the demand for capital goods is the same in its nature as moving from the conditions of Figure 15–6, with its national income of 400 and rapid capital accumulation and economic progress, to the conditions of Figure 15–5, with its national income of 500 and economic stagnation. Thus, American conservatives can continue to cherish both small government and balanced budgets, secure in the knowledge that both are essential requirements of economic progress and prosperity, even if in the conditions of a given quantity of money and volume of spending, they mean a smaller national income—indeed, precisely because they mean a smaller national income in such conditions. 73

---

Thus, this chapter has conclusively demonstrated in every way the overwhelming role of saving and productive expenditure in the generation of aggregate demand. In the process, it has rid the science of economics of significant elements of seeming paradox and given good indication of the importance of sound ideas concerning saving and spending for the rest of economic theory.

Notes

1. See above, pp. 442–447.

2. It is appropriate to acknowledge here the profound identification made by Ayn Rand that “It is axiomatic concepts that identify the precondition of knowledge: the distinction between existence and consciousness, between reality and the awareness of reality, between the object and the subject of cognition.” See Ayn Rand, Introduction to Objectivist Epistemology, 2d ed. enl., ed. Harry Binswanger and Leonard Peikoff (New York: NAL Books, 1979), p. 57.

3. See above, pp. 442–447.

4. On the subject of productive consumption, see above, pp. 131–132 and 443–446.

5. Adam Smith, The Wealth of Nations (London, 1776), bk. 2, chap. 3; reprint of Cannan ed. (Chicago: University of Chicago Press, 2 vols. in 1, 1976), 1:351–371. Italics supplied. (From now on, specific page references to the University of Chicago Press reprint will be supplied in brackets.)

6. James Mill, Commerce Defended, (London, 1808) chap. 6; reprinted in Selected Economic Writings of James Mill, ed. Donald Winch (Chicago: University of Chicago Press, 1966), pp. 128–129.

7. The classical economists were not consistent on this point. Thus, Adam Smith states: “Whatever part of his stock a man employs as a capital, he always expects to be replaced to him with a profit. He employs it, therefore, in maintaining productive hands only; and after having served in the function of a capital to him, it constitutes a revenue to them.” Wealth of Nations, bk. 2, chap. 3 [p. 353]. Italics supplied.

8. Paul Samuelson and William Nordhaus, Economics, 13th ed. (New York: McGraw Hill Book Company, 1989), p. 103. The only contemporary economist I am aware of whose treatment of GNP does not follow along the lines of Samuelson and Nordhaus, but rather of the classical economists and myself in recognizing the production of the socalled intermediate goods, is Mark Skousen. See his Economics on Trial (Homewood, Ill.: Business One Irwin, 1991), pp. 38–43, and The Structure of Production (New York: New York University Press, 1990), pp. 191–192. In these pages, he advances the concepts of “Gross National Outlays” (GNO) and “Gross National Output,” which are similar to, though still considerably smaller than, my concept of Gross National Revenue (GNR) that is presented in this chapter on pp. 706–707.

9. Samuelson and Nordhaus, p. 107.

10. Ibid.

11. Ibid., p. 109.

12. Gardner Ackley, Macroeconomic Theory (New York: The Macmillan Company, 1961), p. 28. To his credit, Ackley is aware that “Final products might be limited to consumer goods and goods sold to the government (collective consumption).” (Ibid.) He is aware that the actual contemporary practice of including the production of plant and equipment in GNP represents a contradiction of the final products approach. He writes: “There is much to be said for the idea that new capital goods are not final products. They are certainly not wanted for their own sake, but only to produce (directly or indirectly) other final products. The machine services which contribute to the production of bread are essentially like the flour. Machine methods are more productive than hand methods; therefore machinery is produced and used. But sooner or later this production of machines means that more bread will be produced than otherwise. Having counted the production of bread, this argument would have it that we should not also count the production of machinery.”(Ibid., p. 29.)

13. Lloyd G. Reynolds, Economics, 5th ed. (Homewood, Ill.: Richard D. Irwin, 1985) p. 80.

14. Ibid. Italics supplied.

15. Ibid., pp. 80–81. Italics supplied.

16. John Stuart Mill, Principles of Political Economy, Ashley ed. (1909; reprint ed., Fairfield, N. J.: Augustus M. Kelley, 1976), pp. 79–81.

17. George Leland Bach, Economics, 6th ed. (Englewood Cliffs, N. J.: Prentice-Hall, Inc., 1968), p. 40. Italics supplied.

18. Armen A. Alchian and William R. Allen, University Economics, 3d ed. (Belmont, Calif.: Wadsworth Publishing Company, 1972), p. 530. Italics supplied.

19. These considerations, and the rest of this subsection, imply, of course, that the socalled accelerator doctrine of the Keynesians is completely mistaken. For the accelerator doctrine explains increases in the aggregate demand for capital goods on the basis of increases in the aggregate demand for consumers’ goods. For further discussion of this error, see below, n. 22 of this chapter.

20. See above, pp. 475–480.

21. See above, pp. 140–141.

22. Perhaps the best that can be said for the proponents of the idea that increases in the aggregate demand for consumers’ goods are the cause of increases in the aggregate demand for factors of production is that they confuse the effects of increases in the aggregate demand for consumers’ goods with the effects of increases in the quantity of money or decreases in the demand for money for holding. Under such conditions, in which aggregate monetary demand increases, an increase in the demand for consumers’ goods is probably accompanied by an increase in the demand for factors of production. But it would have been accompanied by a greater increase in the demand for factors of production if the increase in consumption were smaller. In that case saving, the indispensable precondition of the demand for factors of production, would have been greater and thus so too would have been the demand for factors of production.

23. The precise nature of this relationship will become clearer in the elaboration of the theory of profit and the role played by an excess of consumption expenditure over wage payments in determining an excess of demand for products over demand for factors of production and thus of sales revenues over costs. See below, pp. 725–736. See also below, pp. 689–690.

24. See above, p. 301 and pp. 650–653. See also pp. 653–655. 25. See again above, pp. 653–655.

26. This fact is clearly recognized in the theory of profit and interest propounded by von Mises under the name the theory of originary interest. Cf. von Mises, Human Action, 3d ed. rev. (Chicago: Henry Regnery Co., 1966), pp. 526–527.

27. See, for example, the extensive quotation from Samuelson and Nordhaus, a few paragraphs below in the text.

28. Samuelson and Nordhaus, pp. 167–168.

29. For elaboration of this point, see below, pp. 707–708. 30. See below, pp. 702–705, for a discussion of the nature of

net investment.

31. On these points, see above, pp. 622–629 and 631–634. 32. See, for example, Samuelson and Nordhaus, p. 168. 33. Cf. ibid., pp. 153 and 181, where investment is described as “autonomous”—viz., emanating from outside the system. 34. For examples of these errors, see again Samuelson and Nordhaus, pp. 176–183.

35. See above, pp. 573–573.

36. On the nature of consumption and capital, see above, pp. 444–447.

37. Cf. U.S. Department of Commerce, Office of Business Economics, National Income, 1954 ed. (Washington, D. C.: U.S. Government Printing Office, 1954), p. 164.

38. On the harmful effects of government interference with the fall in wages and prices in a depression, see above, pp. 580–594. On the deflationary potential of fractional reserve banking, see above, pp. 513–514.

39. A further significant point that deserves mention in connection with “hoarding” is that it operates to speed the adjustment process of the fall in wages and prices that is necessary to restore full employment. This is because in reducing spending, it increases the pressure on wage rates and prices to fall. See Murray N. Rothbard, Man, Economy, and State, 2 vols. (Princeton, N. J.: D. Van Nostrand Company, Inc., 1962), 2:691–692. 40. See below, pp. 954–963.

41. As I have already shown, revenue and income that is saved is also typically spent faster than revenue and income that is consumed. On this point, see above, p. 518.

42. The employment statistics can be found in The Federal Reserve Bulletin, September, 1993, p. A45.

43. For elaboration of this point, see below, pp. 843–847. 44. See below, pp. 778–787.

45. Such government expenditures, of course, are fully consistent with the principle that business is the source of its own demand. This is because the taxes that finance them are always paid either directly by business enterprises themselves, by wage earners and dividend and interest recipients with funds received from business enterprises, or by people who receive funds from the members of these groups, such as domestic servants. 46. On this subject, see below, pp. 739–741. To an important but lesser extent, taxes on wages also reduce the demand for capital goods and labor. They reduce it insofar as their effect is to reduce the savings of wage earners, who then either cannot finance productive expenditure to the same extent or are led to borrow savings in competition with business, in order to finance their purchase of expensive consumers’ goods, such as housing and automobiles.

47. For a full account of these effects, see below, pp. 922–950. 48. J. S. Mill, Essays on Some Unsettled Questions of Political Economy (1844; reprint ed., New York: Augustus M. Kelley, 1968) pp. 48–49. To be fully accurate, one need only add to Mill’s position recognition of the fact that production and employment can be held far below their potential limit at any given time by government interference in the monetary system and the consequent boom-bust pattern of business activity, and that such damage can be indefinitely protracted by further government interference in the form of maintaining artificially high wage rates and prices in the contraction phase. See above, pp. 580–594 and 938–942.

49. See above, pp. 559–580.

50. On the role of saving in capital accumulation and a rising productivity of labor, see above, pp. 622–629 and 631–632. See also below, p. 824.

51. For the discussion of natural resources, see above, pp. 63–66. 52. See above, pp. 622–629, especially Figures 14–4 and 14–5 and the surrounding discussion.

53. On this last point, see above, pp. 531–533.

54. See, for example, Samuelson and Nordhaus, pp. 110–116. 55. See below, p. 705.

56. See, for example, Samuelson and Nordhaus, p. 165, Figure 8–10, which is titled “HOW CONSUMPTION AND INVESTMENT

DETERMINE OUTPUT.”

57. Concerning my treatment of interest, see below, pp. 720– 721. Previous discussion, on pp. 456–459, has made it clear that most of what is described as net rental income of persons in today’s national income accounts is purely fictional in nature. It should be obvious in the light of that discussion that any actual net rental income, whether in letting rooms or apartments, houses, automobiles, computers, or whatever, is profit. 58. See above, pp. 444–447.

59. The use of lower-case s c to represent sales revenues paid by consumers should not be confused with the previous use of upper-case S C to represent the supply of consumers’ goods produced and sold, especially since the former is actually interchangeable with the demand for consumers’ goods, D C . Also, I use the subscript b rather than p , to avoid confusion with aggregate profit, which is represented by p. One can think of b as standing for business expenditure, which, of course, is synonymous with productive expenditure.

60. It should be realized that while productive expenditure is an expenditure, net investment is not. As the difference between productive expenditure and business costs, its actual nature is that of an accounting abstraction, not an expenditure.

61. See above, pp. 690–691, in particular the quotation from Samuelson and Nordhaus.

62. See above, pp. 622–642.

63. This is the case in the context of an invariable money and its fixed aggregate demand for the products of business, which is the essential analytical framework for establishing causal relations in economics. In such conditions an increase in saving and the demand for capital goods is both an absolute increase and a relative increase at the same time.

64. See above, pp. 624 and 625.

65. See above, pp. 444–447.

66. They also exclude costs on account of interest. However, our practice, it should be recalled, is to count interest and “net rental income of persons,” which are the two remaining components of national income, as part of profits. See above, this page, n. 57. Because it is not germane to the present analysis, we also omit from consideration incomes generated in the socalled consumer and government sectors, notably the demand for consumers’ labor.

67. The fact that sales revenues minus costs on account of capital goods equals profits plus wages was previously demonstrated in connection with the exposition of the Marxian exploitation theory. See above, pp. 605–607.

68. I must point out that the national income earned in connection with the sales revenues of a given year includes an import—

ant component that was earned in previous years, and that an important component of the national income earned in the current year is earned in connection with sales revenues to be brought in, in future years. For example, part of the national income earned in connection with this year’s sales revenues represents wages paid in the previous year (or earlier years) to workers who helped to produce items held in this year’s opening inventories. It also includes significant amounts of wages paid as far back as previous decades and generations to workers who helped to build plant and equipment in existence at the beginning of the current year. By the same token, part of the wages paid this year are credited to inventory and plant and equipment accounts and will be chargeable against sales revenues only next year and, to be sure, in future decades and generations. As a result, it does not follow that national income in any given year exceeds the consumption expenditure of that particular year exclusively by the excess of the current demand for capital goods over the costs deducted from sales revenues on account of capital goods.

69. For a discussion of the destructive effects of inflation on capital accumulation, see below, pp. 930–938.

70. See above, pp. 622–629, especially Figures 14–4 and 14–5 and the surrounding discussion. There the reader will see the basis of the derivation of the specific outputs of capital goods and consumers’ goods in each year of Figure 15–6.

71. See, for example, Samuelson and Nordhaus, Economics, 13th ed., pp. 181–182; Willis L. Peterson, Principles of Economics Macro, 6th ed. (Homewood, Ill.: Richard D. Irwin, Inc., 1986), pp. 235–236; Gordon Philpot, The National Economy, An Introduction to Macroeconomics (New York: John Wiley & Sons, 1980), p. 81. The balanced-budget-multiplier doctrine was originated by Trygve Haavelmo, and presented for the first time in his article, “The Multiplier Effects of a Balanced Budget,” Econometrica, October 1945.

72. See Philpot, National Economy, p. 81.

73. It should be realized that national income and economic prosperity are also inversely related in the case in which a rise in national income is brought about by means of an increase in the taxation of wage earners and use of the proceeds to raise the demand for labor. See above, pp. 648–650.