Will Savings Save Us?
The subject of financing the needs of an increasing portion of elderly people is a matter of growing concern in many countries. Given the current demographic trends, the established systems of social security are no longer viable to guarantee the standards of the past.
As a remedy, governments have initiated programs to foster private savings programs in order to provide a supplement to the governmental old age insurance systems. This way, old-age pension is said to gain an additional foothold, as the public pay-as-you-go system is accompanied by private capital-based systems.
The incentive created by government to do more private financial investing in order to save for retirement is the result of the failure of the Social Security system to deliver its promises. But like the pretense that it is government that would guarantee wealth accumulation, savings under the umbrella of pension and investment funds are also prone to create an illusion with the promise that these vehicles represent guaranteed forms of the preservation and accumulation of wealth.
While the deficiencies of state-run old-age pension schemes are well known, it is less recognized that the problems posed by large demographic shifts cannot be easily overcome either by capital-based systems or by other forms of private saving. Savings per se do not solve the problem. The heart of the matter is that saving is not the same as real capital formation, and that the connection between today's capital formation and future economic growth is less strict than aggregate macroeconomic models assume.
Austrian capital theory in the tradition of Menger, Hayek, and Mises reminds us that monetary saving is not necessarily investment, and investment is not necessarily capital formation which renders yields and could bring forth appreciation by some compound interest formula. Real capital does not exist as a homogenous lump in the sense that there is a capital stock that enters the production function to produce the national income. Real capital exists in the forms of diverse capital goods, and as such, they do not represent a source of a permanent income. In a nonstationary economy, capital goods render an income stream only insofar as they are constantly rearranged and renewed according to the changing market conditions. Capital without entrepreneurial activity is an empty concept.
The term "capital" as it is frequently used and applied when calculating the financial state of households, companies, and pension funds is purely an accounting concept.[i] Only in terms of accounting can capital be said to be preserved or accumulated. In contrast to monetary capital, real capital, as it is represented by heterogeneous capital goods, has a limited period of usefulness. Capital goods wear down by rendering the yield, and they easily become obsolete when the production process must be altered because technology or specific demand has changed.
Current consumption comes from current production. The goods that will be required for the satisfaction of the needs of a growing portion of elderly in the future cannot be preproduced now and saved for consumption later on. It will be the state of the economy at the point of time in the future when the consumption needs arise that determines the degree of meeting the new specific demands. Because future demand will be different from today's pattern, the capital structure currently in existence will become inadequate, and it is only by constant adaptation and new capital formation that the production process will provide the flow of consumption goods in future periods.
High investment rates now are said to bring forth increased productivity, which would provide the basis to sustain a larger portion of economically inactive persons in the future. But given the different needs of an aging population, higher productivity now does not mean that its level can be maintained, or that the areas where high productivity shows up now will be the same that will be needed in the future.
In contrast to the thesis that high saving now would guarantee prosperity later on due to the accumulation of capital, Austrian capital theory leads to the conclusion that without continuous rearrangement and the production of new capital goods, productivity cannot be maintained. Whatever the level of savings and investment now, in a relatively short period of time it will be almost exclusively the availability of new funds and their entrepreneurial management by which the level of wealth will be determined.
The accumulation of financial assets may be regarded as investment from a personal perspective, but it does not necessarily mean that real capital will be created. Most of the stock trade is pure rotation. In a generational shift, when a strong cohort discovers the stock market as a vehicle for retirement savings, the direct effect will be an increase in stock prices which later will tend to fall when this cohort enters retirement age and begins to withdraw the funds.
Even less so does lending to government constitute the acquisition of capital goods. Governments spend most of the money on salaries and other items that are mostly consumption. In terms of saving via government bonds, there is little difference between a pay-as-you-go system and a capital-based system, because in both cases the savings of one group is consumption by another one, and no real capital formation takes place.
In interventionist and socialist economic systems, high savings and investment rates go along with capital destruction. But in capitalist countries, too, high rates of savings, investment, and economic growth can be very deceiving indicators about the future performance of an economy. If it were merely aggregate investment that mattered, economic development and continuous wealth creation would be child's play. Poor economies could become rich overnight by borrowing abroad; and rich economies, where sufficient savings potential is available, could deliberately choose their desired future wealth levels.
A similar illusion is in place when saving for old age via pension funds and the other vehicles deemed to augment financial security for retirement. The major impact of higher inflows into these instruments is a change of ownership and higher asset prices. But it is not ownership by itself in the form of stock and bond holding that is the source of income and wealth; rather, it is the entrepreneurial use made of the capital goods in the production process.[ii]
Only insofar as the money gets into the hands of companies that are able to adapt to market conditions will savings contribute to future prosperity. It is the entrepreneurial quality of the management and the overall socioeconomic conditions that determine whether the savings are put to proper use or squandered.
Popular thinking about economic growth is still strongly influenced by the productivity theory of capital, which presumes that capital engenders the yield like the fruits from a tree. In the models of high aggregate macroeconomics, too, saving and investment come to be seen as the main sources of growth. In this view, more saving implies more investment, and more investment means a higher capital stock, which in turn augments future yields. When discussing old-age pension, the assumption of a proper fertility of capital is sometimes even transferred to the accumulated monetary capital as it is represented by an investment portfolio which is said to grow more or less automatically toward higher returns.
Only as an accounting tool--as "monetary capital"--can capital be measured and said to grow or to diminish. But capital in the sense of capital goods cannot be expected to grow or to be stored for a long time. On the contrary. By the very act of rendering yield, they lose their value. Capital goods deteriorate during production and finally actually disappear from the process of production. It is not accumulated monetary capital that brings forth output and renders profits and interest, but only capital in real terms as a heterogeneous ensemble of capital goods, and as such, it renders yield only insofar as it is constantly remodeled by entrepreneurs who buy labor, find and employ new techniques, and adapt the structure of production to changing conditions.
An individual member of a generational cohort may improve his position in relation to the average by currently saving more, but it will be the state of the economy in the future that determines the level of well-being in absolute terms. The savings will contribute to the aim of maintaining an adequate capital structure when the money gets into the hand of capable entrepreneurs and when society maintains an environment where the entrepreneurial qualities are allowed to thrive.
Expecting future returns from the stock market as a wealth-generation machine is as foolish an idea as the belief that the government actually pays for social security checks. The expectation that it is primarily financial investment now that guarantees future yields is illusory, like the promise by the state social security system that more contributions now guarantee higher pensions later. By concentrating on financial schemes, the focus is diverted from the real issue to an accounting concept. Then, higher stock market valuations appear as real wealth creation, and it gets ignored that it is not the price of an asset that constitutes wealth but the solid profits that come from the process of production.
There is no escape from permanent efforts to rearrange the production process. The future levels of wealth are linked to the overall conditions of the economy as it evolves in time. The need of constant renewal of real capital requires an on-going flow of funds in terms of free capital in order to maintain the production process.[iii] Financial assets will appreciate insofar as net savings continue to be generated in the future and if they get into the hands of able entrepreneurs. Saving and investment will be pure waste when companies are run by managers who lack foresight and prudence or when institutional settings emerge that hamper, transform, and destroy these entrepreneurial qualities.
Dr. Antony P. Mueller is a professor of economics at the University of Erlangen-Nuremberg, Germany. He was a Fulbright Scholar in the U.S. and currently serves as a long-term visiting professor at the Universidade Federal de Santa Catarina in Florianópolis, Brazil, under the German-Brazilian academic exchange program. He is an adjunct scholar of the Mises Institute and recently contributed to the QJEA. Send him MAIL, and see his Mises.org Articles Archive.
[i] Ludwig von Mises, Human Action, pp. 517, Auburn, Alabama, The Mises Institute, 1998.
[ii] Ludwig Lachmann, The Market Economy and the Distribution of Wealth, p. 674, in: Richard M. Ebeling (ed.), Austrian Economics. A Reader, Hillsdale, Michigan 1991, pp. 670-686 (The Ludwig von Mises Lecture Series, Vol. 18).