Saving (1)

Not consuming everything you produce

If you like heated arguments where economists are talking past each other, and often accusing each other of being naive or outright malicious, try bringing up the topic of saving. Some say that saving causes unemployment and recession, while others argue that saving is essential for prosperity. To see who’s right, let’s look at the subject in 2 stages: we’ll start in this article with a simple Robinson Crusoe situation, and next week see how things are different in a modern society where there are lots of people, and debts exist (including money).

Bob Crusoe

Bob has been shipwrecked, and finds himself alone on an island which is surprisingly circular. After exploring, he finds there are plenty of streams where he can get water for drinking and washing, and he discovers a decent-sized cave in the south where he can shelter from the weather. But he doesn’t have any food to eat, or fuel for warmth, light and cooking. Fortunately there’s plenty of food growing in the north-west of the island, and there’s a forest in the north-east where he can get firewood. Both are about 5 miles away from the cave, and 4 miles from each other.

The island where Bob is shipwrecked

Bob discovers that, at any one time, he can carry both 1 day’s food and 1 day’s firewood.

Simple approach

One simple approach Bob could take is to gather (a form of production) each day just what he needs for that day. He can have a daily routine: go to the north-west to collect one day’s food, walk across to the north-east to collect one day’s firewood, and bring them back to the cave to consume.

A day in Bob’s life on the island

We can see from the diagram that he’s consuming everything he produces.

Coping with unproductive days

A problem with collecting everything on the day he needs it is that if he can’t collect what he needs one day for some reason (e.g. the weather makes it impossible to travel, or he’s badly hurt his leg), he can’t eat or keep warm until he’s able to travel again. If it’s a long enough period, he might not even survive.

There’s a good solution to this. While he’s fit, and the conditions are good, he makes 2 trips each day, gathering 2 days’ food and 2 days’ firewood. He uses just the food and fuel he needs that day, and stores the rest at the back of the cave.

A day when Bob produces 2 days’ food and fuel

We can see that his raw net worth¹ has increased by 2 days’ food and 2 days’ fuel, and then decreased by 1 day’s food and 1 day’s fuel. This leaves him with 1 day’s food and 1 day’s fuel more than he had at the start of the day.

After 4 weeks, he’s built up a stock of 28 days’ food and fuel, and decides to go back to gathering just 1 day’s food and fuel each day.

Now his situation is much less precarious. If for some reason he can’t gather food or fuel for a few days, he can still consume by taking from his stock at the back of the cave.

This stock he’s built up is his savings. It’s the things he’s produced and not yet consumed. Since he isn’t owed and doesn’t owe anything, this is his raw net worth. That’s not a coincidence! We’ll see that someone’s RNW is their savings.

A day when Bob has to consume from his savings

If Bob uses 7 days’ food and fuel from his savings because it’s been pouring with rain and the paths are too muddy to walk on for a week, he still has 21 days of savings left. Then once he can start producing again, he can rebuild his savings to 28 days’ worth by producing twice as much as he needs for the first 7 days, and then settling back to just producing at the rate he consumes.

Reducing time and effort

Another advantage of building up savings is that it gives Bob the flexibility to be more efficient. Collecting food and firewood for 1 day involves a 14-mile round trip (5 + 4 + 5). But if he has savings of both, he can save himself both time and effort by only producing one type of thing each day. If he alternates between collecting 2 days’ food one day, and 2 days’ firewood the next, he only needs to do a 10-mile round trip each day, and he can save himself an hour or two. He can use that time to relax, or perhaps work on a plan to make his way back to civilisation.

Bob alternating between collecting 2 days’ food and 2 days’ fuel

If Bob hadn’t built up savings of firewood to start with, then this wouldn’t work because he wouldn’t be able to have a fire on the first odd day.

Limits to savings

There are some limits to how much it’s possible for Bob to save. Here are a few:

1. There might not be enough plants producing food, or trees producing firewood, for Bob to be able to gather 3 or more days’ worth each day for a sustained period. Overproduction in some cases might even reduce how much can be produced in future (e.g. if Bob collects so much barley that there aren’t any seeds for new barley to grow).

2. Savings take up space, so the amount of storage space available limits how much can be saved.

3. Savings can deteriorate in storage, which is wasted consumption. (Some of Bob’s food might rot, without him getting any benefit out of it). If carrots only last 4 weeks, there’s no point in keeping 8 weeks’ worth in stock - at least not unless you can find a way to preserve them.

Generalising to a group

Imagine a community which doesn’t interact with anyone outside the group. (This applies to the world as a whole²). Any debts owed by someone in the community are owed to someone in the community and vice-versa. Bob can represent this entire community, so everything which applies to Bob also applies to an isolated community. Its savings are its raw net worth, which is the sum of its saved tangible assets (what it’s produced but hasn’t yet consumed), because every debt asset is cancelled out by the corresponding liability and vice-versa.

Production adds P to the world’s savings and consumption takes C from its savings

Summary

An isolated person (or an isolated community, including the world as a whole) can save by producing more than it consumes. In fact, it’s best to think of production as adding to savings and consumption as taking from savings, rather than production being consumed. Saving allows the person or community to consume later without having to produce, by taking from the stock of savings (which of course runs down the stock).

A stock of savings makes a community more resilient against periods when it can’t produce as much as it consumes (e.g. war, famine, disease). It also provides flexibility, allowing for longer-term planning. Apart from the storage space needed, and potentially the potential over-exploitation of limited resources while building up savings, the effects of savings are positive, and often extremely beneficial.

1. Someone’s raw net worth (RNW) is what they own plus what they’re owed minus what they owe. It is a “heterogeneous” sum/difference, which just means that things of different types are added and subtracted, not monetary “values” which have been assigned to them.

2. Unless there are aliens I don’t know about, in which case it applies to the world and all the other planets involved in interstellar trade as a group.