Why Economicst Need to Speak the Language of the Marketplace; J. Ahiakpor

THEFREEMAN IDEASON LIBERTY Why EconomistsNeed to Speak the Language of the Marketplace James c. w. Ahiakpor A sk a group of economists whether sav ing is necessary to promote investment and economic growth, and you will get a variety of responses. Some would claim that the answer depends on whether the econ omy is operating at "full employment," since outside of full employment their an swer is no. Others would simply say no, it is rather investment which makes savings pos sible. A minority however would say defi nitely, without saving there can be nothing to invest. Indeed, a debate last summer among historians of economic thought on the internet well illustrates this amazing state of confusion among economists over an issue so fundamental as the primacy of saving to make investment possible. So how did economists get into this state of affairs? Trace it to the publication of Keynes' General Theory (1936), in which he argues what is now called' 'The Paradox ofThrift. "

Keynes' claim is that saving at the national level is bad for an economy because when people decide to save more rather than Dr. Ahiakpor is Professor and Chairman of the Department o/Economics, California State Uni versity, Hayward. This article is based on his itA Paradox ofThrift or Keynes's Misrepresentation of Saving in the Classical Theory of Growth?," published in the Southern Economic Journal, Vol. 62, July 1995, pp. 16-33. consume, they deprive producers of market demand. As a result, production contracts, fewer people are hired, less income is gen erated, and the community becomes poorer. And with lower incomes, people will actu ally save less than they initially intend ed-so the argument goes. But a community in which people decide to consume more than save would create more demand for producers who will hire more workers, and thus create more income from which more savings will flow. And interest rates are not supposed to react to the changing desires of the public to save. Through this reasoning, Keynes believes he found "an explanation of the paradox of poverty in the midst of plenty, " namely, the problem of wealthy communities making themselves poorer by their inclination to save.!

Keynes' argument defies sound logic, al though many economics textbooks teach it as if it were valid. Even some of the few who cast doubt on the empirical validity of Keynes' claim, nevertheless insist that the propositionis theoreticallysound.2 Modern dissenters from Keynes' fallacy, especially Henry Hazlitt, have had little luck dissuad ing a majority of the academic economics community from teaching the doctrine that increased saving is a public vice.3 Some students who go on to fields such 785 786 THE FREEMAN • DECEMBER 1995 as development economics or finance are taught that the public's. saving in the form of purchasing (private) financial assets is conducive to economic growth. But many still get stuck in a state of ambivalence, never being sure whether saving is logically prior to investment. Such is the state of economics education that Axel Leijonhuf vud calls Keynes' paradox of thrift "one of the most dangerous and harmful confu sions ever taught as accepted economic doctrine, " but this critique has had little effect in eradicating its teaching. 4 The key to this dilemma for economists is their continued use of the term saving as Keynes defines it in his General Theory (e.g., pp. 81, 166-67) such that it could mean the hoarding of cash, which is incon sistent with language of the marketplace as well as the teachings of economists before him, including Adam Smith,David Ricardo, and Alfred Marshall. Indeed, when people think of saving, they do not plan to accu mulate in cash portions of their monthly paychecks under their mattresses or in their stockings. Rather they think of putting such funds in a bank account, savings or credit union to earn interest, or play the stock market (for capital gains or dividends), or buy bonds for interest income (or capital gains, should they sell them before bond the redemption date). Thus, as Marshall states in his Money, Credit and Commerce, " ...

in 'western' countries even peasants, if well to do, incline to invest the greater part of their savings in Government, or other famil iar stock exchange securities, or to commit them to the charge of a bank. ,,5 This is why the act of saving is not "the negative act of refraining from spending the whole of [one's] current income on consumption" as Keynes claims it is in his Treatise.6 But rather, saving is spending on future incomeearning assets. . Another way to clarify the active, rather than passive, act that saving really is, is to note that it is not the same thing as hoarding one's income in cash. Henry Hazlitt's crit icism of Keynes on the paradox of thrift proposition focuses on the fact that hoarding is occasioned by government's disturbance of the people's confidence which leads to their preference not to hold financial assets. In The Failure of the "New Economics," Hazlitt also quotes David Ricardo's correct criticisms of Malthus for the latter's con cerns over excessive saving which could (in Malthus' mistaken mind) be injurious to effective demand. 7 But Malthus' firm state ment of the meaning of saving, in which he declares that "No political economist of the present day can by saving mean mere hoard ing," better helps to illustrate the error of Keynes 'association of hoarding or non spending with saving.8 Similarly, John Stu art Mill's clarification of the meaning of saving in his Principles helps a great deal.

He says: The word saving does not imply that what is saved is not consumed, nor even nec essarily that its consumption is deferred, but only that, if consumed immediately, it is not consumed by the person who saves it. If merely laid by for future use, it is said to be hoarded; and while hoarded, is not consumed at all. But if employed as cap ital, it is all consumed [spent]; though not by the capitalist. 9 Understood as the classical economists taught, and the general public means in common usage in the marketplace, in creased saving does not depress total spend ing, but only shifts the composition of spending more towards investment or pro ducers' goods and less towards immediate satisfaction of consumption demand. Such understanding helps easily to set aside the analytical fable called the paradox of thrift, promoted to a great extent by Paul Samuel son's bestselling textbook, Economics, by which increased saving depresses aggregate demand or total _spendingand causes a fall in subsequent level of income.

The great teachers of economics sought to communicate ideas in the language of the marketplace. Indeed, Alfred Marshall urges economists to do the same, arguing in regard to the term "capital" that "economists have no choice but to follow well-established cus toms as regards the use of the term capital in ordinary business, i.e. trade-capital.,,10 ECONOMISTS AND THE LANGUAGE OF THE MARKETPLACE 787 Keynes is known to have made up his own meaning for terms in ordinary usage, much to the confusion of his audience. And many of Keynes' modern-day followers continue with his distortion of language , as in the case of associating saving with the hoarding of cash, and hence a refusal to spend or "a withdrawal from the spending stream. " Ac cordingly, modern Keynesians derive some surprising conclusions, e.g., Samuelson and Nordhaus' warning against "President Reagan's tax cuts put forth as a means of promoting [private sector] saving" in the United States, and that governments should promote consumption, not saving. 11 But saving is not hoarding. It is what most people understand it to be: buying or invest ing in financial assets issued by banks and other borrowers or investors. This is why savings promote economic growth, as the classical economists taught before Keynes changed the language of modern economics so drastically to the detriment of meaningful dialogue or communication between econ omists and the rest of the public. D 1. John Maynard Keynes, The General Theory of Em ployment, Interest and Money, paperbound ed. (London and Basingstoke: Macmillan, 1974 [1937]), p. 30.

2. See, for instance, J. Vernon Henderson and William Poole, Principles of Economics (Lexington, Mass.: D.C. Heath, 1991), pp. 279-81, and Michael Parkin, Macroeco nomics, 2nd ed. (New York: Harper and Row, 1993), pp. 224-25. 3. See Henry Hazlitt, The Failure of the "New Econom ics" (Princeton, N.J.: Van Nostrand, 1959) and Economics in One Lesson (Westport, Conn.: Arlington House, 1978 [1962]). Also see Mark Skousen, Economics on Trial(New York: Irwin, 1991),ch. 5, and Dissent on Keynes (New York: Praeger, 1992), ch.5. 4. Axel Leijonhufvud, Information and Coordination (New York: Oxford University Press, 1981), p. 197. 5. Alfred Marshall, Money, Credit and Commerce (New York: Kelly, 1960 [1923]), p. 46 6. John Maynard Keynes, A Treatise on Money makes a similar claim in his General Theory (London: Macmillan, 1930), vol. 1, p. 172, emphasis in original. Keynes makes a similar claim in his General Theory (p. 210).

7. Hazlitt (1959, p. 218) makes the point that "people in a modem economic community do not simply hoard money in a sock or under the mattress," but does not focus on Keynes' distortion of saving as defined by the classics. 8. Quoted in Mark Blaug, Economic Theory inRetrospect, 4th ed. (Cambridge: Cambridge University Press, 1986),p. 166. 9. John Stuart Mill, Collected Works, vol. 2, ed. by J. M. Robson (London: University of Toronto Press, 1965), p. 70. 10. Alfred Marshall, Principles of Economics, 8th ed. (London: Macmillan, 1964 (1920]), p. 64/. See James C. w. Ahiakpor, "On Keynes's Misinterpretation of 'Capital' in the Classical Theory of Interest," History of Political Economy, Vol. 22, Fall 1990, pp. 507....28. Ahiakpor explains how Keynes' failure to follow this meaning of "capital" led to his inability to recognize Marshall's explanation of the theory of interest, that is, the rate of interest is determined by the supply and demand for "capital." In place of that valid explanation, Keynes then substitutes the supply and demand for liquidity (cash) as being the determinants of interest rates, a confusion which continues to plague economists.

11. Paul A. Samuelson and William D. Nordhaus, Econom ics, 12th ed. (New York: McGraw-Hill, 1985), pp. 171-74. Why not try a FREE issue and decide for yourself? For a complimen tary copy, a $3.75 value, call 1·800·829·6270 or write us at 165 E. 56th St., New York, N.Y. 10022 parallel in American journalism." We think you will find COMMENTARY a bracing change. Next Year in (a Divided?) Jerusalem / David Bar-Illan The Case for Global Activism / Robert Kagan Furtive Smokers: An Exchange / Peter L. Berger & Critics Books in Review: Cathy Young / Jack Wertheimer / John Corry / Ben Wildavsky / Arch Puddington PUBLISHED BY THE AMERICAN JEWISH COMMITTEE $3.75/$4.50 CANADA Lessons from the Soviet Collapse / Charles H. Fairbanks The ADL vs. the "Religious Right" / Midge Deeter Clement Greenberg: An Appreciation / Roger Kimball Flop at the OK Corral/Richard Grenier VOLUME NINETY-EIGHT· NUMBER THREE· SEPTEMBER 1994 We weren't always right.

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