WEBVTT NOTE 9. "The Propensity To Consume": I 1 00:00:00.000 --> 00:00:08.000 Chapter 9 The Propensity to Consume, Part 1 2 00:00:08.000 --> 00:00:14.000 Digression on Mathematical Economics 3 00:00:14.000 --> 00:00:24.000 When we come in the general theory to the two chapters on the propensity to consume, we meet all our previous difficulties magnified. 4 00:00:24.000 --> 00:00:36.000 1. A specialized and self-coined technical vocabulary to cover complex concepts, which, however, are never consistently adhered to. 5 00:00:36.000 --> 00:00:43.000 2. Loose, unverified, unverifiable or meaningless statements. 6 00:00:43.000 --> 00:00:49.000 3. A constant confusion or scrambling of cause and effect. 7 00:00:49.000 --> 00:01:06.000 4. The same aversion to and derision of anything resembling individual thrift, prudence or forethought that was evident 16 years previously in the economic consequences of the peace. 8 00:01:06.000 --> 00:01:16.000 In the general theory, in brief, Keynes did not suddenly discover that the traditional economic virtues were really vices and vice versa. 9 00:01:16.000 --> 00:01:26.000 He had practically always thought so. All that he hit upon was a new rationalization for his old bias. 10 00:01:26.000 --> 00:01:35.000 The ultimate object of our analysis, he begins, is to discover what determines the volume of employment. 11 00:01:35.000 --> 00:01:50.000 So far we have established the preliminary conclusion that the volume of employment is determined by the point of intersection of the aggregate supply function with the aggregate demand function, page 89. 12 00:01:50.000 --> 00:01:58.000 Here we meet two special Keynesian technical terms, so we look back to remind ourselves what they mean. 13 00:01:58.000 --> 00:02:04.000 And on page 25, we find the so-called definition, 14 00:02:04.000 --> 00:02:12.560 Let z be the aggregate supply price of the output from employing n men. The relationship 15 00:02:12.560 --> 00:02:20.400 between z and n being written z equals phi n, which can be called the aggregate supply 16 00:02:20.400 --> 00:02:27.360 function. Similarly, let d be the proceeds which entrepreneurs expect to receive from 17 00:02:27.360 --> 00:02:36.240 on the employment of n men, the relationship between d and n being written d equals f n, 18 00:02:36.240 --> 00:02:41.080 which can be called the aggregate demand function. 19 00:02:41.080 --> 00:02:47.960 Here we have not so much two definitions as two mathematical equations, each of which 20 00:02:47.960 --> 00:02:51.520 expresses a complex relationship. 21 00:02:51.520 --> 00:02:57.400 If the volume of employment is determined by the point of intersection of the aggregate 22 00:02:57.400 --> 00:03:03.800 supply function with the aggregate demand function, then the volume of employment depends 23 00:03:03.800 --> 00:03:10.340 upon the relationship between two complex relationships. This ought to be difficult 24 00:03:10.340 --> 00:03:17.580 enough to keep in mind, but our troubles have only begun. For, if we go back to Keynes's 25 00:03:17.580 --> 00:03:20.860 definitions on page 25. 26 00:03:20.860 --> 00:03:25.880 We find that while the aggregate supply function depends upon the relationship between two 27 00:03:25.880 --> 00:03:33.660 actualities, supply price and number of men employed, the aggregate demand function depends 28 00:03:33.660 --> 00:03:41.740 upon the relationship between an expectation of proceeds and an actuality, number of men 29 00:03:41.740 --> 00:03:43.820 employed. 30 00:03:43.820 --> 00:03:50.540 Most logicians or mathematicians would doubtless agree that some actualities could be equated 31 00:03:50.540 --> 00:03:58.540 with other actualities, and some expectations with other expectations. 32 00:03:58.540 --> 00:04:05.320 But I doubt whether many would agree that expectations could be mixed up with actualities 33 00:04:05.320 --> 00:04:11.820 in the same mathematical goulash, or that the resulting equations could have any precise 34 00:04:11.820 --> 00:04:36.820 and if a mathematical equation is not precise, it is worse than worthless. It is a fraud. It gives our results a merely spurious precision. It gives an illusion of knowledge in place of the candid confession of ignorance, vagueness or uncertainty which is the beginning of wisdom. 35 00:04:36.820 --> 00:04:47.820 A short digression seems desirable at this point, not merely on Keynes's mathematical economics, but on mathematical economics in general. 36 00:04:47.820 --> 00:05:00.820 It is said in defense of mathematical economics, by, for example, Keynes's father, John Neville Keynes, in The Scope and Method of Political Economy, that 37 00:05:00.820 --> 00:05:11.820 That, Exact numerical premises are not always essential to the employment of mathematical methods, page 257. 38 00:05:11.820 --> 00:05:21.820 Mathematical methods, in other words, can still be useful in economics even when they do not deal with known or even determinable quantities, 39 00:05:21.820 --> 00:05:27.820 but are a means of clarifying merely hypothetical relationships. 40 00:05:27.820 --> 00:05:35.820 Francis Edgeworth, for example, in his Mathematical Physics, 1881, writes, 41 00:05:57.820 --> 00:06:18.820 To take a trivial instance, A is greater than B, and B is greater than C, therefore A is 42 00:06:18.820 --> 00:06:25.900 greater than C. Here is mathematical reasoning applicable to quantities which may not be 43 00:06:25.900 --> 00:06:47.900 All this is doubtless true, but the mathematical economists who make such points then tend to forget that out of a merely hypothetical equation or set of equations, they can never pull anything better than a merely hypothetical conclusion. 44 00:06:47.900 --> 00:06:49.900 As Whitehead remarks, 45 00:06:50.900 --> 00:06:56.900 The conclusion of no argument can be more certain than the assumptions from which it starts. 46 00:06:57.900 --> 00:07:10.900 If mathematicians cannot in some way or other determine the numerical values of their x's and y's, their equations are useless for applied or applicable economics. 47 00:07:10.900 --> 00:07:17.900 And Keynes's general theory professes to be a theory applicable to real situations. 48 00:07:17.900 --> 00:07:23.900 He does, in fact, constantly profess to apply it to real situations. 49 00:07:23.900 --> 00:07:27.900 But we may go much further in our criticism. 50 00:07:27.900 --> 00:07:32.900 Even a merely hypothetical equation may be worse than worthless 51 00:07:32.900 --> 00:07:54.900 A mathematical statement to be scientifically useful must, like a verbal statement, at least be verifiable, even when it is not verified. 52 00:07:54.900 --> 00:08:11.900 If I say, for example, and am not merely joking, that John's love of Alice varies in an exact and determinable relationship with Mary's love of John, I ought to be able to prove that this is so. 53 00:08:11.900 --> 00:08:20.900 I do not prove my statement, in fact, I do not make it a whit more plausible or scientific, if I write solemnly, 54 00:08:20.900 --> 00:08:33.900 let X equal Mary's love of John and Y equal John's love of Alice, then Y equals FX, and go on triumphantly from there. 55 00:08:33.900 --> 00:08:42.900 Yet, this is the kind of assertion constantly being made by mathematical economists, and especially by Keynes. 56 00:08:42.900 --> 00:08:46.900 The model was set by Augustin Cournot in his 57 00:08:46.900 --> 00:08:51.900 L'écheve sur le principe mathématique de la cellulite de la tisse 58 00:08:51.900 --> 00:08:56.900 published more than a century ago, in 1838. 59 00:08:56.900 --> 00:09:01.900 Let us admit therefore that the sales or the annual demand d 60 00:09:01.900 --> 00:09:10.900 is, for each article, a particular function, fp, of the price, p, of such article. 61 00:09:10.900 --> 00:09:18.900 And he went on to explain how a curve can be made to represent the function in question. 62 00:09:18.900 --> 00:09:24.900 It is from this that the famous Marshallian supply and demand curves later developed, 63 00:09:24.900 --> 00:09:30.900 and today's immense and bewildering body of mathematical economics. 64 00:09:30.900 --> 00:09:41.900 Yet there is no proof whatever that even the most elementary of these functional economic equations represents a fact of the real world. 65 00:09:41.900 --> 00:09:48.900 There is no proof that demand is a particular function of the price of a particular article. 66 00:09:48.900 --> 00:09:52.900 We can, of course, assume such a relationship. 67 00:09:52.900 --> 00:10:02.900 We can draw a hypothetical demand curve, and derive from it a hypothetical functional relationship between demand and price. 68 00:10:02.900 --> 00:10:16.900 We can then point out that according to our hypothetical curve and hypothetical table, when the hypothetical price of our hypothetical commodity is x, the amount demanded will be y. 69 00:10:16.900 --> 00:10:27.900 When the price is X1, the amount demanded will be Y1. When the price is X2, the amount demanded will be Y2, etc. 70 00:10:27.900 --> 00:10:36.900 We can, in short, assert that a general hypothetical relationship implies specific hypothetical relationships. 71 00:10:36.900 --> 00:10:45.900 But of what practical use will all these deductions be? Is there any way in which we can apply them to the real world? 72 00:10:45.900 --> 00:10:52.900 When we ask this, we find that our mathematical equations are of very little use indeed. 73 00:10:52.900 --> 00:11:00.900 For whether our hypothetical demand curve corresponds to any real demand curve, we can never know. 74 00:11:00.900 --> 00:11:05.900 Our equation is useful only on the completely unreal assumption 75 00:11:05.900 --> 00:11:28.900 More unreal still, our equation is valid only for one state of demand, which cannot be assumed to exist for more than an instant of time. 76 00:11:28.900 --> 00:11:48.900 We can never tell whether a real change of price, between, say, today's closing price of wheat and yesterday's closing price of wheat, is the result of a change, or supposed change, in supply, or the result of a change in the state of demand, or demand curve. 77 00:11:48.900 --> 00:11:55.940 In short, we can draw all the beautiful supply and demand curves we like and cross them at 78 00:11:55.940 --> 00:11:58.740 the points that please us most. 79 00:11:58.740 --> 00:12:05.700 We can thus help to clarify ideas for college freshmen and even for ourselves, but we constantly 80 00:12:05.700 --> 00:12:12.980 run the danger of deceiving ourselves by our own diagrams, of giving ourselves the illusion 81 00:12:12.980 --> 00:12:16.880 that we know what we in fact do not know. 82 00:12:16.880 --> 00:12:24.200 For these supply and demand curves are merely analogies, metaphors, visual aids to thought, 83 00:12:24.200 --> 00:12:28.120 which should never be confused with realities. 84 00:12:28.120 --> 00:12:35.480 We never in fact do know what the present demand curve or demand schedule is for anything. 85 00:12:35.480 --> 00:12:38.440 We can only guess. 86 00:12:38.440 --> 00:12:45.340 Historical research or past statistics, and all statistics describe events in the past, 87 00:12:45.340 --> 00:12:51.960 may help entrepreneurs to do this guessing and reduce their range of error, but such 88 00:12:51.960 --> 00:12:58.080 statistics can never enable entrepreneurs to know any future relationships of price 89 00:12:58.080 --> 00:13:04.420 to demand or enable economists to predict it with confidence. 90 00:13:04.420 --> 00:13:11.560 Supply and demand curves and functional equations assume that an infinite number or an indefinitely 91 00:13:11.560 --> 00:13:24.560 A fairly large range of simultaneous relationships can be known, and even known in advance, but as the physicists would say, this is not an operational concept. 92 00:13:24.560 --> 00:13:44.560 All that we can know is that, say, in 1956 the average price of wheat was P and the supply was S, whereas in 1957 the average price of wheat was P minus P1 and the supply was S plus S1. 93 00:13:44.560 --> 00:13:53.560 But were the supply curves and the demand curves exactly the same in 1956 and 1957? 94 00:13:53.560 --> 00:14:01.560 Are the differences caused merely by the supply curves crossing the same demand curve at different points? 95 00:14:01.560 --> 00:14:07.560 This we can never know, and the obtainable market data will never tell us. 96 00:14:07.560 --> 00:14:13.560 Nor do we improve the situation from a theoretical or mathematical standpoint, 97 00:14:13.560 --> 00:14:20.560 when instead of average annual prices we take average monthly or weekly or daily prices, 98 00:14:20.560 --> 00:14:24.560 or prices from hour to hour or minute to minute. 99 00:14:24.560 --> 00:14:33.560 As a matter of fact, on the organized speculative markets, we do not find that when the price of a commodity or a share goes up, 100 00:14:33.560 --> 00:14:42.560 the amount sold invariably falls, or that when the price goes down, the amount sold invariably increases. 101 00:14:42.560 --> 00:14:48.660 Often, the price and the amount sold will both increase, or the price and the amount 102 00:14:48.660 --> 00:14:51.500 sold will both decline. 103 00:14:51.500 --> 00:14:58.640 A typical supply and demand curve exposition tacitly assumes, say, that a demand curve 104 00:14:58.640 --> 00:15:05.320 remains fixed while a supply curve moves up and down and crosses it at different points, 105 00:15:05.320 --> 00:15:08.540 which constitute the changing prices. 106 00:15:08.540 --> 00:15:13.800 But the truth is that the level and shape of the supply curve, and more particularly 107 00:15:13.800 --> 00:15:20.460 of the demand curve, are themselves constantly changing from hour to hour. 108 00:15:20.460 --> 00:15:26.420 If they could really be discovered and put on a motion picture film, we might find them 109 00:15:26.420 --> 00:15:32.140 writhing, vibrating, and jumping in a way to discourage even the cockiest mathematical 110 00:15:32.140 --> 00:15:34.160 economist. 111 00:15:34.160 --> 00:15:40.400 The stationary supply and demand curves of the textbooks, or the few alternatives shown, 112 00:15:40.400 --> 00:15:47.080 are grossly simplified static assumptions, and should never be taken for more than that. 113 00:15:47.080 --> 00:15:53.400 The attempt to put demand and price into a functional equation, and worse than this, 114 00:15:53.400 --> 00:15:59.380 the belief that in real life we could discover a set of actual numerical values to which 115 00:15:59.380 --> 00:16:03.500 such an equation would apply, is chimerical. 116 00:16:03.500 --> 00:16:10.020 A little mathematical economics here and there, to repeat, or occasional diagrams, may be 117 00:16:10.020 --> 00:16:17.380 useful for clarifying or generalizing some economic concepts, for making them more precise, 118 00:16:17.380 --> 00:16:23.140 or for protecting us against some errors that otherwise might not be recognized. 119 00:16:23.140 --> 00:16:30.140 But the great bulk of mathematical economics today is a manipulation of hypothetical abstractions 120 00:16:30.140 --> 00:16:35.140 that have no useful application to the real world. 121 00:16:35.140 --> 00:16:41.420 Keynes does not advance in the slightest beyond Cournot in setting up his own functions and 122 00:16:41.420 --> 00:16:42.900 his own formulas. 123 00:16:42.900 --> 00:16:47.300 In fact, as we shall see, he goes backward. 124 00:16:47.300 --> 00:16:54.500 His equations are not merely unverified and unverifiable, they are invalid or inadmissible 125 00:16:54.500 --> 00:16:56.540 in other ways. 126 00:16:56.540 --> 00:17:26.540 Let us begin, as an example, with 127 00:17:26.540 --> 00:17:32.540 is that entrepreneurs practically never think or act in the way Keynes implies. 128 00:17:32.540 --> 00:17:39.540 The entrepreneur usually begins by trying to determine what his net income will be 129 00:17:39.540 --> 00:17:46.540 from producing a certain quantity of a certain product and selling it at a certain price. 130 00:17:46.540 --> 00:17:54.540 Only when he has made this estimate does he decide how many men will be needed to turn out this product. 131 00:17:54.540 --> 00:18:03.240 How many men he hires or keeps, moreover, will also be determined heavily by the wage rates he is obliged to pay. 132 00:18:03.240 --> 00:18:09.040 Instead of thinking what his gross proceeds will be from hiring so and so many men, 133 00:18:09.040 --> 00:18:19.740 he decides how many men he will have to hire, or how many he can afford to hire at a given wage rate, to acquire a certain net income. 134 00:18:19.740 --> 00:18:26.940 His decision will also be governed, of course, by how much capital he has, or can borrow. 135 00:18:26.940 --> 00:18:32.440 But a Keynesian is never allowed to look at the matter the way an entrepreneur looks at it. 136 00:18:32.440 --> 00:18:42.540 Under threat of excommunication, he is not even permitted to hint that the amount of employment will have anything to do with wage rates. 137 00:18:42.540 --> 00:18:49.140 That unemployment might be primarily the result of excessive wage rates in relation to prices, 138 00:18:49.140 --> 00:18:57.140 or the Demand for Products is the very doctrine that Keynes started out to disprove and to ridicule. 139 00:18:57.140 --> 00:19:03.140 Thus, there is no reason to suppose, and there is the most serious reason to doubt, 140 00:19:03.140 --> 00:19:11.140 that the causal relationship is the one tacitly assumed by Keynes in the equation d equals f n. 141 00:19:11.140 --> 00:19:17.140 Nor is there any reason to suppose that the equation expresses a truth. 142 00:19:17.140 --> 00:19:23.900 And there are too many factors, tangible and intangible, which entrepreneurs and consumers 143 00:19:23.900 --> 00:19:30.060 must take into account in their plans, which do not get into the equation. 144 00:19:30.060 --> 00:19:35.980 And there is no way of showing or knowing, even when an infinite number of other factors 145 00:19:35.980 --> 00:19:41.840 are assumed to remain unchanged or equal, that the functional relationship expressed 146 00:19:41.840 --> 00:19:45.480 in the equation actually exists. 147 00:19:45.480 --> 00:19:51.040 How could this functional relationship be proved? We have already seen that this was 148 00:19:51.040 --> 00:19:58.040 impossible, even in the simpler and more orthodox functional relationship postulated by Cournot. 149 00:19:59.400 --> 00:20:05.880 The Keynesian functional relationship cannot, in fact, be proved. It can only be arbitrarily 150 00:20:05.880 --> 00:20:12.880 and dogmatically asserted. And this is typical of practically all the Keynesian equations. 151 00:20:12.880 --> 00:20:17.880 The Fundamental Psychological Law 152 00:20:17.880 --> 00:20:29.880 Because of the foregoing digression on mathematical economics, it has seemed to take unconscionable space to analyze even a few Keynesian paragraphs. 153 00:20:29.880 --> 00:20:39.880 But we have really made far more progress than the distance so covered in Keynes's first chapter on the propensity to consume may imply. 154 00:20:39.880 --> 00:20:47.780 For once we have recognized the slipperiness, vagueness, and changeability of most of Keynes's 155 00:20:47.780 --> 00:20:54.160 basic terms and concepts, and his habit of begging the question by unproved mathematical 156 00:20:54.160 --> 00:21:01.440 equations and sheer assertion, we can begin to economize in our analysis. 157 00:21:01.440 --> 00:21:07.200 Still on the first page of the first propensity to consume chapter, we come to the assertion 158 00:21:07.200 --> 00:21:13.200 Note that the factors which govern two quantities, the sum which will be spent on consumption 159 00:21:13.200 --> 00:21:19.240 when employment is at a given level, and the sum which will be devoted to investment, are 160 00:21:19.240 --> 00:21:26.200 largely distinct, therefore we are told these two quantities will be discussed not only 161 00:21:26.200 --> 00:21:34.280 in separate chapters, but in separate books of the general theory, pages 89 through 90. 162 00:21:34.280 --> 00:21:41.480 But if we go back to Keynes's own equation that income equals consumption plus investment, 163 00:21:41.480 --> 00:21:47.600 or if we turn merely to common sense, we might conclude that every dollar of income spent 164 00:21:47.600 --> 00:21:54.640 on consumption goods must leave a dollar less to be spent on investment goods, while every 165 00:21:54.640 --> 00:22:02.520 dollar spent on investment must leave a dollar less to be spent on immediate consumption. 166 00:22:02.520 --> 00:22:08.300 How the factors governing two quantities related to each other as subtrahend and remainder 167 00:22:08.300 --> 00:22:15.260 could be largely distinct is puzzling, but we shall postpone consideration of this paradox 168 00:22:15.260 --> 00:22:17.680 to a later stage. 169 00:22:17.680 --> 00:22:24.960 We come at last to the famous Keynesian concept of the propensity to consume. 170 00:22:24.960 --> 00:22:30.780 We will therefore define what we shall call the propensity to consume as the functional 171 00:22:30.780 --> 00:22:45.780 A Real Relationship Between YW, A Given Level of Income in Terms of Wage Units and CW, The Expenditure on Consumption out of that level of income, page 90 172 00:22:45.780 --> 00:22:49.780 Keynes creates several difficulties here as usual. 173 00:22:49.780 --> 00:22:57.780 is trying to define the relationship of consumption to income in real rather than in monetary terms. 174 00:22:57.780 --> 00:23:01.780 And therefore he talks in terms of wage units. 175 00:23:01.780 --> 00:23:13.780 But we have seen, page 64, that Keynes so defines the wage unit as to make it in fact a concept that can only be conceived in monetary terms. 176 00:23:13.780 --> 00:23:29.780 These wage units are added together exactly in proportion to monetary wages, because an hour of special labor remunerated at double ordinary rates will count as two units, page 41. 177 00:23:29.780 --> 00:23:40.780 We must forget wage units, therefore, in order to substitute what Keynes thought he was comparing, which is real consumption with real income. 178 00:23:40.780 --> 00:23:48.780 The difficulty to be dealt with is the misleading nature of the term itself, propensity to consume. 179 00:23:48.780 --> 00:23:55.780 Keynes's definition shows that he is not in fact dealing with a propensity in the dictionary sense, 180 00:23:55.780 --> 00:24:00.780 a natural or habitual inclination or tendency. 181 00:24:00.780 --> 00:24:03.780 He is dealing with a mathematical relationship. 182 00:24:03.780 --> 00:24:18.780 He is dealing with the fraction or percentage of its income that the community in fact spends on consumption goods at different levels of income, regardless of what its propensities or inclinations may be. 183 00:24:18.780 --> 00:24:31.780 If the community spends 90% or 9 tenths of its income on consumption, then its propensity to consume is 9 tenths or 9 over 10. 184 00:24:31.780 --> 00:24:36.780 But the term, it can now be seen, is doubly misleading. 185 00:24:36.780 --> 00:24:42.780 The propensity part of it is not a propensity, but a function or a fraction. 186 00:24:42.780 --> 00:24:47.780 And we are not even talking about the fraction of income that is spent, 187 00:24:47.780 --> 00:24:52.780 but only the fraction that is spent on consumption goods. 188 00:24:52.780 --> 00:24:58.780 If a man buys a capital good, this is not counted in his propensity to consume, 189 00:24:58.780 --> 00:25:01.780 Because this purchase is called an investment. 190 00:25:01.780 --> 00:25:08.780 If a doctor, however, buys a house, and this house is both his residence and his office, 191 00:25:08.780 --> 00:25:11.780 how is this term entered on the Keynesian ledger? 192 00:25:11.780 --> 00:25:16.780 As part of the doctor's propensity to consume, or as an investment? 193 00:25:16.780 --> 00:25:25.780 If you buy a power mower strictly to use on your own lawn, it is doubtless part of your propensity to consume. 194 00:25:25.780 --> 00:25:30.780 If you buy it to rent out to others, it is an investment. 195 00:25:30.780 --> 00:25:37.780 But what is it if you use it partly for your own lawn and partly to rent out to others? 196 00:25:37.780 --> 00:25:46.780 Such questions are enough to show that the line between consumption goods and capital goods, between consumption and investment, 197 00:25:46.780 --> 00:25:53.780 is not as clear and sharp as Keynes's elaborate theoretical division implies. 198 00:25:53.780 --> 00:26:14.780 But they indicate also that from a practical standpoint, it is irrelevant to the immediate total volume of employment, whether a given amount of money is spent on consumption or on capital goods, whether it is to be included under the propensity to consume or under investment. 199 00:26:14.780 --> 00:26:22.780 In fact, they raise the further question whether, from the standpoint of the immediate effect on the volume of employment, 200 00:26:22.780 --> 00:26:29.780 there is any difference between the dollars that go into consumption and the dollars that go into investment, 201 00:26:29.780 --> 00:26:36.780 and therefore, whether there is any good reason for dealing with each by two separate sets of equations, 202 00:26:36.780 --> 00:26:43.780 or for that matter, whether there is any good reason for the whole elaborate structure of Keynesian theory. 203 00:26:43.780 --> 00:26:51.540 Of course, it makes a great deal of difference to the direction or allocation of employment 204 00:26:51.540 --> 00:26:57.700 whether money is spent on consumption or on capital goods, but it also makes a good deal 205 00:26:57.700 --> 00:27:04.100 of difference to the direction or allocation of employment whether money is spent on one 206 00:27:04.100 --> 00:27:10.800 consumption good rather than another, say on houses rather than on automobiles, or on 207 00:27:10.800 --> 00:27:15.440 on Beef rather than on Television Machines. 208 00:27:15.440 --> 00:27:21.200 At this point, Keynes digresses to discuss the Rate of Interest, but it will help the 209 00:27:21.200 --> 00:27:27.800 exposition here if we do not follow him in this digression but reserve criticism of his 210 00:27:27.800 --> 00:27:34.200 interest rate theories until we come to his chapters 13 and 14 wholly devoted to the Rate 211 00:27:34.200 --> 00:27:36.140 of Interest. 212 00:27:36.140 --> 00:27:42.900 The next point for us to pass on to, therefore, is Keynes's fundamental law upon which his 213 00:27:42.900 --> 00:27:49.400 confidence in the alleged propensity to consume function is based. 214 00:27:49.400 --> 00:27:55.380 The fundamental psychological law upon which we are entitled to depend with great confidence 215 00:27:55.380 --> 00:28:02.800 both a priori from our knowledge of human nature and from the detailed facts of experience 216 00:28:02.800 --> 00:28:08.800 is that men are disposed, as a rule and on the average, to increase their consumption 217 00:28:08.800 --> 00:28:15.340 as their income increases, but not by as much as the increase in their income. 218 00:28:15.340 --> 00:28:24.940 That is to say, if Cw is the amount of consumption and Yw is income, both measured in wage units, 219 00:28:24.940 --> 00:28:31.980 the function of Cw has the same sign as the function of Yw, but is smaller in amount, 220 00:28:31.980 --> 00:28:39.820 i.e. dcw over dyw is positive and less than unity. 221 00:28:39.820 --> 00:28:42.300 Page 96. 222 00:28:42.300 --> 00:28:48.820 Before starting to analyze this, it is important to emphasize the central role that this alleged 223 00:28:48.820 --> 00:28:56.100 consumption function plays in Keynesian economics, and the huge importance his admirers and disciples 224 00:28:56.100 --> 00:28:57.980 attach to it. 225 00:28:57.980 --> 00:29:06.020 Keynes's most notable contribution, writes Alvin H. Hansen, was his consumption function. 226 00:29:06.020 --> 00:29:13.460 The behavior patterns of the community are such that a gap exists, which gap widens absolutely 227 00:29:13.460 --> 00:29:20.420 as real income increases, between the amount the community wishes to consume and the output 228 00:29:20.420 --> 00:29:24.500 the community is capable of producing. 229 00:29:24.500 --> 00:29:30.360 But let us allow Keynes to explain a little further exactly what he means. 230 00:29:30.360 --> 00:29:37.620 This fundamental psychological law is both a secular and a cyclical law, and is apparently 231 00:29:37.620 --> 00:29:45.380 considered even more important as an explanation of business cycles than as a secular law. 232 00:29:45.380 --> 00:29:51.180 Continuing without gap from the quotation from Keynes above, this is especially the 233 00:29:51.180 --> 00:29:59.180 This is the case where we have short periods in view, as in the case of the so-called cyclical fluctuations of employment. 234 00:29:59.180 --> 00:30:07.180 Thus, a rising income will often be accompanied by increased saving, and a falling income by decreased saving. 235 00:30:07.180 --> 00:30:17.180 But apart from short period changes in the level of income, it is also obvious that a higher absolute level of income will tend, as a rule, 236 00:30:17.180 --> 00:30:21.180 to widen the gap between income and consumption. 237 00:30:21.180 --> 00:30:29.180 These reasons will lead, as a rule, to a greater proportion of income being saved as real income increases. 238 00:30:29.180 --> 00:30:38.180 But whether or not a greater proportion is saved, we take it as a fundamental psychological law of any modern community, 239 00:30:38.180 --> 00:30:46.180 that when its real income is increased, it will not increase its consumption by an equal absolute amount, 240 00:30:46.180 --> 00:30:52.180 so that a greater absolute amount must be saved, page 97. 241 00:30:52.180 --> 00:31:02.180 Now, how does Keynes try to establish this great discovery, this fundamental psychological law, on his mere say-so? 242 00:31:02.180 --> 00:31:10.180 Had he put this forward merely as a loose common-sense observation with no mathematical equations based on it 243 00:31:10.180 --> 00:31:28.180 Of course the consumption function is normally less than unity, page 96. 244 00:31:28.180 --> 00:31:36.180 This is merely a pretentious way of saying that a community cannot as a whole consume more than it produces, 245 00:31:36.180 --> 00:31:53.180 and that any community that has advanced beyond the most primitive and miserable state will save against contingencies at least part of what it produces and invest something in land improvement and tools to increase its future production. 246 00:31:53.180 --> 00:32:01.180 It is also true that richer people will, as a rule, save a greater proportion of their incomes than poorer people 247 00:32:01.180 --> 00:32:08.180 for the simple reason that they have more above their present bare minimum consumption requirements to save, 248 00:32:08.180 --> 00:32:13.180 and some saving is the course dictated by common prudence. 249 00:32:13.180 --> 00:32:20.180 But such truths in this loose general form have been known from time immemorial. 250 00:32:20.180 --> 00:32:25.180 They were embedded in Proverbs long before the birth of Adam Smith, 251 00:32:25.180 --> 00:32:30.180 and no one has hitherto called them a great economic discovery. 252 00:32:30.180 --> 00:32:34.740 But let us listen again, for a moment, to Hansen. 253 00:32:34.740 --> 00:32:39.380 Even a little reflection on the course of economic history is enough to disclose the 254 00:32:39.380 --> 00:32:46.340 unmistakable fact that consumption has risen, broadly conceived, more or less in proportion 255 00:32:46.340 --> 00:32:53.500 to the spectacular growth in productivity which the last 150 years have witnessed, whoever 256 00:32:53.500 --> 00:32:56.140 supposed otherwise. 257 00:32:56.140 --> 00:33:02.780 To this general knowledge, long and widely held, Keynes indeed added something very important, 258 00:33:02.780 --> 00:33:09.220 namely the precise formulation of the consumption income schedule, together with the concept 259 00:33:09.220 --> 00:33:12.420 of the marginal propensity to consume. 260 00:33:12.420 --> 00:33:18.620 And more significant still, he developed a theory in which this and other functions relevant 261 00:33:18.620 --> 00:33:22.580 to the determination of aggregate demand are integrated. 262 00:33:22.580 --> 00:33:39.580 In brief, Keynes took a loose truism that everybody knew and turned it into a double error, first by attributing a precision to it that it simply does not have, and secondly by making it the basis of a false theory. 263 00:33:39.580 --> 00:33:48.580 I have said that Keynes tried to establish his fundamental psychological law by mere assertion, by an ipsy dixit. 264 00:33:48.580 --> 00:33:58.580 There are two major ways in which an economic law, or any scientific law, might be established, deductively or inductively. 265 00:33:58.580 --> 00:34:09.580 In the deductive hypothetical method, a truth is established because it is a demonstrable implication of another truth already known or postulated. 266 00:34:09.580 --> 00:34:15.580 This is the kind of truth embodied in the ordinary laws of supply and demand. 267 00:34:15.580 --> 00:34:23.580 If the supply of an article remaining unchanged, the demand for it increases, the price will rise. 268 00:34:23.580 --> 00:34:31.580 If, with no increase in the demand for an article, the price is raised, less of it will be bought, etc. 269 00:34:31.580 --> 00:34:41.580 The conclusion follows inevitably from the premises, and from the very meaning of such terms as supply, demand and price, 270 00:34:41.580 --> 00:34:49.580 or if one wishes to be more precise and technical, of such terms as the curve of price and amount demanded, 271 00:34:49.580 --> 00:34:53.580 the curve of price and amount offered, etc. 272 00:34:53.580 --> 00:35:01.580 In economics, induction consists usually either of common observations or of statistics. 273 00:35:01.580 --> 00:35:10.580 Economic truths, like truths in almost all fields, are never established by pure induction or pure deduction, 274 00:35:10.580 --> 00:35:13.580 but by a combination of both methods. 275 00:35:13.580 --> 00:35:19.580 From hypothetical premises, only hypothetical conclusions can be drawn. 276 00:35:19.580 --> 00:35:29.580 For a conclusion to be true and to have practical application, the premises must be known, from common observation or otherwise to be true. 277 00:35:29.580 --> 00:35:39.580 In confirming a conclusion, statistics at best present nothing more than presumptive evidence, for they can never be complete. 278 00:35:39.580 --> 00:35:59.620 Now, though Keynes declares that his fundamental psychological law of the relation of consumption 279 00:35:59.620 --> 00:36:07.620 to income can be arrived at not only a priori, but, from the detailed facts of experience, 280 00:36:07.620 --> 00:36:12.340 He never deigns to offer the slightest statistical confirmation. 281 00:36:12.340 --> 00:36:16.920 We can only assume that this is because he has none to offer. 282 00:36:16.920 --> 00:36:23.820 When we do look at available statistics, we find in fact a prima facie refutation of his 283 00:36:23.820 --> 00:36:27.300 fundamental psychological law. 284 00:36:27.300 --> 00:36:33.140 Here is a table taken from official statistics showing the disposable personal income in 285 00:36:33.140 --> 00:36:40.140 In the year 1944, income was $146.8 billion, savings were $36.9 billion, and savings as a percent of income was 25.2%. 286 00:37:03.140 --> 00:37:20.140 In the year 1945, income was $150.4 billion, savings were $28.7 billion, and savings as a percent of income were 19.1%. 287 00:37:20.140 --> 00:37:36.140 In the year 1946, income was $159.2 billion, savings were $12.6 billion, and savings as a percent of income was 7.9%. 288 00:37:36.140 --> 00:37:51.140 In the year 1947, income was $169 billion, savings were $4 billion, and savings as a percent of income were 2.4%. 289 00:37:51.140 --> 00:38:07.140 In the year 1948, income was $187.6 billion, savings were $10 billion, and savings as a percent of income were 5.3%. 290 00:38:07.140 --> 00:38:23.140 In the year 1949, income was $188.2 billion, savings were $7.6 billion, and savings as a percent of income were 4%. 291 00:38:23.140 --> 00:38:39.140 In the year 1950, income was $206.1 billion, savings were $12.1 billion, and savings as a percent of income was 5.9%. 292 00:38:39.140 --> 00:38:56.140 In the year 1951, income was $226.1 billion, savings were $17.7 billion, and savings as a percent of income was 7.8%. 293 00:38:56.140 --> 00:39:12.140 In the year 1952, income was $236.7 billion, savings were $18.4 billion, and savings as a percent of income was 7.8%. 294 00:39:12.140 --> 00:39:28.140 In the year 1953, income was $250.4 billion, savings were $19.8 billion, and savings as a percent of income was 7.9%. 295 00:39:28.140 --> 00:39:44.140 In the year 1954, income was $254.8 billion, savings were $18.3 billion, and savings as a percent of income was 7.2%. 296 00:39:44.140 --> 00:40:01.140 And in the year 1955, income was $269.4 billion, savings were $17.1 billion, and savings as a percent of income was 6.3%. 297 00:40:01.140 --> 00:40:07.140 Now let us see what these figures do to Keynes's alleged psychological law. 298 00:40:07.140 --> 00:40:08.700 Law. 299 00:40:08.700 --> 00:40:15.140 The events of 1955 were in themselves an emphatic contradiction. 300 00:40:15.140 --> 00:40:24.360 Disposable personal income increased by $14.6 billion, but savings fell by $1.2 billion. 301 00:40:24.360 --> 00:40:32.240 The total percentage of saving to disposable income fell from 7.2% to 6.3%. 302 00:40:32.240 --> 00:40:46.240 The same thing happened between 1953 and 1954. Disposable income went up $4.4 billion, savings down $1.5 billion. 303 00:40:46.240 --> 00:40:54.240 How many times Keynes's law was falsified in this 12-year period depends on how the law is interpreted. 304 00:40:54.240 --> 00:40:59.240 Total income went up each year as compared with the preceding year. 305 00:40:59.240 --> 00:41:09.240 If we take the amount of saving in 1944 as our base figure, therefore, the law was falsified in every one of the succeeding 11 years, 306 00:41:09.240 --> 00:41:16.240 for income was higher in each than in 1944, but savings were lower. 307 00:41:16.240 --> 00:41:37.240 If we interpret Keynes's law or consumption function, as he calls it, to mean merely that savings must rise in absolute amount when incomes rise, but only as compared with the preceding year, then Keynes's consumption function was falsified in six years and worked in only five. 308 00:41:37.240 --> 00:41:53.240 If we interpret the consumption function to mean that savings will rise as a percentage of income with every rise in income, then Keynes's law was falsified in seven of the eleven years and followed only in four. 309 00:41:53.240 --> 00:42:01.440 I may be accused of unfairness for including the enormous savings in 1944 and showing their 310 00:42:01.440 --> 00:42:10.400 decline in 1945, 1946 and 1947 in spite of substantial rises in disposable income in 311 00:42:10.400 --> 00:42:12.720 each year. 312 00:42:12.720 --> 00:42:20.240 It will be said that savings were heavy in 1944 and 1945 because these were war years 313 00:42:20.240 --> 00:42:23.160 and consumer goods were not available. 314 00:42:23.160 --> 00:42:29.320 This is indeed part of the answer, but this only underlines the fact that Keynes's law 315 00:42:29.320 --> 00:42:35.880 is no law, and that the relationship of spending and saving does not depend solely on total 316 00:42:35.880 --> 00:42:40.520 income changes, but on innumerable factors. 317 00:42:40.520 --> 00:42:47.240 Savings may depend less on what people earn today than on what they expect to earn tomorrow. 318 00:42:47.240 --> 00:42:53.000 Their spending this year may depend to a large extent on whether they expect the prices of 319 00:42:53.000 --> 00:42:58.360 and the things they want to buy to be higher or lower next year. 320 00:42:58.360 --> 00:43:00.720 People may buy on impulse. 321 00:43:00.720 --> 00:43:05.900 They may refrain from buying through loss of confidence, either in the general business 322 00:43:05.900 --> 00:43:08.860 future or in their own. 323 00:43:08.860 --> 00:43:15.080 These reasons for spending or not spending will be discussed more at length later. 324 00:43:15.080 --> 00:43:21.440 It is sufficient to note here that experience and statistics fail to support the consumption 325 00:43:21.440 --> 00:43:29.160 and Function, which Alvin H. Hansen regards as Keynes's most notable contribution. 326 00:43:29.160 --> 00:43:35.160 There are, I suppose, various ways of refusing to accept the kind of statistical refutation 327 00:43:35.160 --> 00:43:37.640 I have just presented. 328 00:43:37.640 --> 00:43:44.160 One can say that Keynes was not talking about the relation of money-income to money-savings, 329 00:43:44.160 --> 00:43:48.720 but of real incomes to real savings. 330 00:43:48.720 --> 00:44:09.720 Changing the foregoing income figures to figures in terms of constant dollars, e.g. 1956 prices, however, does not change the result much. Only in two years, 1946 and 1947, did the rise in money income cover a fall in real income. 331 00:44:09.720 --> 00:44:21.720 One can argue also, as Hansen apparently does, somewhat obscurely, that when the consumption function fails to work out statistically, it is because it has shifted. 332 00:44:21.720 --> 00:44:28.720 It still exists, and it is a major landmark in the history of economic doctrines. 333 00:44:28.720 --> 00:44:50.720 But if the consumption function is always shifting or can be upset completely by economic upheavals, then its existence can neither be proved nor disproved statistically, or in any other way, and it is worthless for cyclical or even secular prediction. 334 00:44:50.720 --> 00:44:55.720 Ambiguity of the Consumption Function 335 00:44:55.720 --> 00:45:05.720 Before we leave the consumption function, it may be as well to call attention to the uselessness and illegitimacy of the concept in other ways. 336 00:45:05.720 --> 00:45:12.720 The concept is highly ambiguous in what it tells us about the relationship of consumption and income. 337 00:45:12.720 --> 00:45:23.720 On page 116, I present a diagram to illustrate five main functional relationships that saving can bear to total income. 338 00:45:23.720 --> 00:45:45.720 Keynes could easily have clarified this point for himself and his readers by using a similar simple diagram, but though he peppers the general theory with functional and differential equations, he seems to have despised any simple clarifying device and uses only one diagram in the entire book. 339 00:45:45.720 --> 00:45:53.440 For reasons which I shall explain more fully later, it seems to me much more profitable 340 00:45:53.440 --> 00:45:59.440 to discuss the relation of savings to total income than the relation of consumption to 341 00:45:59.440 --> 00:46:07.700 total income. Therefore, I have labeled the lines in the diagram S1, S2, etc., rather 342 00:46:07.700 --> 00:46:19.140 This line, however, merely represents the dividing point between consumption and savings. 343 00:46:19.140 --> 00:46:25.300 The section below the line represents consumption, and the section above the line represents 344 00:46:25.300 --> 00:46:26.900 savings. 345 00:46:26.900 --> 00:46:32.380 The line yy' represents the line of total income. 346 00:46:32.380 --> 00:46:53.380 The vertical line OY represents total income in the year of origin, the vertical line XY' total income in the final year of the diagram, the horizontal line OX the length of time in years over which the rise of income takes place. 347 00:46:53.380 --> 00:47:05.880 The various S-lines representing the dividing lines between savings and consumption all begin at the two-thirds point of the origin year income line O-Y. 348 00:47:05.880 --> 00:47:13.880 This assumes that in the initial year under consideration, saving is equal to one-half of consumption. 349 00:47:13.880 --> 00:47:24.880 This is, of course, a highly unrealistic assumption, because savings normally run, as we shall see, in the neighborhood of about one-tenth of total income. 350 00:47:24.880 --> 00:47:36.880 But the two-thirds point is taken in the origin year simply to make it easier for the eye to follow the various savings lines and not to crowd them into too narrow a space. 351 00:47:36.880 --> 00:47:48.880 For the same reason, the unrealistic assumption is made that the national income in the terminal year of the diagram is three times as great as in the origin year. 352 00:47:48.880 --> 00:48:03.880 Now the line SS1 represents what Keynes appears to be saying in his Psychological Law, namely that as total income increases, the proportion of saving to spending increases. 353 00:48:03.880 --> 00:48:12.880 In the long run, and in the absence of innumerable other disturbing factors, this is indeed what tends to happen. 354 00:48:12.880 --> 00:48:22.880 It is also, as I shall later show, what both the saving individual desires to happen, and what is most beneficial for the community. 355 00:48:22.880 --> 00:48:31.880 If this were what Keynes was saying in his consumption function, and if it were all that he was saying, it would have been true. 356 00:48:31.880 --> 00:48:39.140 would also have been a truth generally recognized not only prior to 1936, but prior to the 357 00:48:39.140 --> 00:48:46.560 birth of Hume and Adam Smith. Those who have more income than they must spend for the immediate 358 00:48:46.560 --> 00:48:53.060 necessities can afford to save something out of the rest. The more income they have above 359 00:48:53.060 --> 00:48:58.840 their immediate necessities, the greater proportion of it they can afford to, and the greater 360 00:48:58.840 --> 00:49:09.840 The same broad relation of savings to income applies both to individuals and to a whole community. 361 00:49:09.840 --> 00:49:17.840 But it applies as a loose rule of thumb generalization, and to the extent that it is true, it must remain one. 362 00:49:17.840 --> 00:49:24.840 The moment it is put into a mathematical equation, as Keynes attempts to put it, it becomes false. 363 00:49:24.840 --> 00:49:42.840 The mathematical precision is spurious. It is useless for practical application or short-run analysis, because the rise of income is only one among many factors, most of them intangible, that determine short-run changes in the volume of saving. 364 00:49:42.840 --> 00:49:59.840 And it is in any case astonishing, as I shall show, to regard the tendency toward increasing proportional saving when income increases as an ominous development that threatens to create secular unemployment and poverty. 365 00:49:59.840 --> 00:50:05.840 The line SS2 represents what could be meant by Keynes's psychological law. 366 00:50:05.840 --> 00:50:14.840 It represents approximately what does happen in reality over a series of years when the increase in income is not substantial. 367 00:50:14.840 --> 00:50:20.840 People tend to save about the same proportion of their income from year to year. 368 00:50:20.840 --> 00:50:33.840 This situation is illustrated by the diagram on page 119, which covers the years divided into quarters from 1951 to 1957 in the United States. 369 00:50:33.840 --> 00:50:49.840 The diagram is reproduced exactly without change of proportions from an official diagram published by the President's Council of Economic Advisers in the April 1958 issue of Economic Indicators. 370 00:50:49.840 --> 00:51:07.840 The chart shows that savings, while they fluctuated mildly over this period, showed no consistent tendency either to increase or decrease, but in general remained at the same proportion of total income, an average of about 7%. 371 00:51:07.840 --> 00:51:15.040 This is in line with what previous attempts to measure savings statistically have shown, 372 00:51:15.040 --> 00:51:20.360 though the proportion of savings to income depends on the particular ways in which savings 373 00:51:20.360 --> 00:51:23.080 and income are defined and measured. 374 00:51:23.080 --> 00:51:31.080 Thus, a study by Koznitz published in 1940 tended to show, in the words of Alvin H. Hansen, 375 00:51:31.080 --> 00:51:32.080 that, 376 00:51:32.080 --> 00:51:38.320 The percent of income saved and invested over the long run has been more or less constant 377 00:51:38.320 --> 00:51:41.860 at say around 12%. 378 00:51:41.860 --> 00:51:48.200 This would look on the surface like a stable situation and a healthy and progressive one. 379 00:51:48.200 --> 00:51:53.740 This saving and investment constantly increases the total amount of consumption and capital 380 00:51:53.740 --> 00:51:55.620 goods produced. 381 00:51:55.620 --> 00:52:01.580 The producers both of consumption and of capital goods could count, by and large, in such a 382 00:52:01.580 --> 00:52:30.300 The proportion of income saved remained substantially constant, but at higher absolute levels of 383 00:52:30.300 --> 00:52:49.540 If the gap in absolute terms between consumption and income widens as income increases, then 384 00:52:49.540 --> 00:52:55.460 aggregate demand will not be adequate to cover the aggregate supply price unless that gap 385 00:52:55.460 --> 00:52:59.460 is filled by an increase in investment. 386 00:52:59.460 --> 00:53:06.020 We shall later inquire whether or not Keynes and Hansen were unduly terrified by the prospect 387 00:53:06.020 --> 00:53:10.420 that saving might rise proportionately with income. 388 00:53:10.420 --> 00:53:15.700 On the same reasoning, Hansen should still be worried even if savings should be represented 389 00:53:15.700 --> 00:53:23.660 by the relation SS3, for though as income increased a smaller percentage of income would 390 00:53:23.660 --> 00:53:30.660 can be saved, it could still be greater in absolute amount than when income was lower. 391 00:53:30.660 --> 00:53:38.660 Only if the relationship were represented by the line SS4 might the souls of the Keynesians be at peace. 392 00:53:38.660 --> 00:53:43.660 Only then might the private enterprise system be allowed to take care of itself 393 00:53:43.660 --> 00:53:50.660 without the solicitous forced spending of the Keynesian bureaucrats to fill the gap. 394 00:53:50.660 --> 00:53:55.860 In fact, the Keynesians might be even more at peace if the relationship were represented 395 00:53:55.860 --> 00:54:03.340 by the line SS5, in which savings would grow smaller and smaller even an absolute amount 396 00:54:03.340 --> 00:54:06.780 as income increased. 397 00:54:06.780 --> 00:54:11.420 The Meaning of Saving 398 00:54:11.420 --> 00:54:18.200 But now a tiny doubt, at first no bigger than a man's hand, begins to grow and grow. 399 00:54:18.200 --> 00:54:24.320 If we accept Keynes's concept of saving, which is quite unrelated to his formal definition 400 00:54:24.320 --> 00:54:31.000 of saving in the general theory, can the Keynesian soul remain at peace as long as there is any 401 00:54:31.000 --> 00:54:38.200 saving at all? Or, to put it more accurately, as long as there is any saving of any amount 402 00:54:38.200 --> 00:54:44.640 that is not compensated or offset by an equal amount of investment? For though Keynes tells 403 00:54:44.640 --> 00:54:50.280 tells us in his formal definitional chapters that he rejects the new-fangled view that 404 00:54:50.280 --> 00:54:57.280 there can be saving without investment or investment without genuine saving, page 83. 405 00:54:57.280 --> 00:55:04.280 And though he himself insists in these chapters on the identity between saving and investment, 406 00:55:04.280 --> 00:55:11.400 page 84, the whole Keynesian theory of unemployment rests on the abandonment of these definitions 407 00:55:11.400 --> 00:55:17.660 Definitions and Concepts, and to return precisely to the now tacit definitions and concepts 408 00:55:17.660 --> 00:55:23.240 that he used in the treatise on money, and that he formally abandons in his definitional 409 00:55:23.240 --> 00:55:30.000 chapters of the general theory, with much regret for the confusions they have caused. 410 00:55:30.000 --> 00:55:32.080 Page 61. 411 00:55:32.080 --> 00:55:38.860 The real, unstated definition and concept that Keynes uses in his Unemployment Theory 412 00:55:38.860 --> 00:55:45.260 is that saving is the merely negative act of failing or refusing to spend money on either 413 00:55:45.260 --> 00:55:50.780 consumption or capital goods, directly or indirectly. 414 00:55:50.780 --> 00:55:56.740 To the extent that a community as a whole can have any such one-sided saving, or pure 415 00:55:56.740 --> 00:56:02.340 hoarding, or to the extent that it is even attempted, whether it can be universally achieved 416 00:56:02.340 --> 00:56:08.660 or not, then it must, other things unchanged, bring about unemployment. 417 00:56:08.660 --> 00:56:15.900 So Keynes did not even need his dubious fundamental psychological law, or his pretentious consumption 418 00:56:15.900 --> 00:56:21.620 function equations, to prove that saving, in the one-sided sense in which he thought 419 00:56:21.620 --> 00:56:24.820 of it, could cause unemployment. 420 00:56:24.820 --> 00:56:27.660 This brings us to still another puzzle. 421 00:56:27.660 --> 00:56:33.500 If Keynes had in the back of his mind this purely negative concept of saving, side by 422 00:56:33.500 --> 00:56:41.500 If I side with a positive concept of investment, why did he talk about a pure consumption function at all? 423 00:56:41.500 --> 00:56:48.500 Unemployment, even on his theory, is not caused by the amount that consumption falls short of income, 424 00:56:48.500 --> 00:56:54.500 but only by the amount that consumption and investment combined fall short of income. 425 00:56:54.500 --> 00:57:00.500 Suppose we were to choose definitions according to which saving and investment would equal each other 426 00:57:00.500 --> 00:57:12.500 in a position of equilibrium or in the long run, but in which for short transitional periods, savings could exceed new investment or investment could exceed real savings. 427 00:57:12.500 --> 00:57:23.500 If Keynes had held such a concept, and this concept is strongly implied in spite of explicit denials in much of what he wrote in The General Theory, 428 00:57:23.500 --> 00:57:29.140 Then it should have occurred to him that the relevant equations for his purposes did not 429 00:57:29.140 --> 00:57:34.820 concern the amount by which consumption alone fell short of income, but the amount by which 430 00:57:34.820 --> 00:57:39.420 consumption and investment together fell short of income. 431 00:57:39.420 --> 00:57:44.780 He would not have worried about the gap between consumption and income, but only about the 432 00:57:44.780 --> 00:57:50.660 far narrower gap between consumption plus investment and income. 433 00:57:50.660 --> 00:57:56.180 It was merely uninvested savings that disturbed him, not all savings. 434 00:57:56.180 --> 00:58:01.540 If he had built his functional equations on such concepts, his exposition might have been 435 00:58:01.540 --> 00:58:05.980 much clearer, and also, of course, his fallacies. 436 00:58:05.980 --> 00:58:13.700 Keynes's fundamental psychological law, as we have seen, is contradicted by experience. 437 00:58:13.700 --> 00:58:18.980 But even if the law were found to exist, it would prove very little about the future of 438 00:58:18.980 --> 00:58:25.340 Overall Employment. It would merely mean that there would be a tendency, and as I shall 439 00:58:25.340 --> 00:58:31.700 later show, a wholly desirable tendency, for a smaller percentage of the working force 440 00:58:31.700 --> 00:58:36.720 to be employed in turning out consumption goods, and a larger percentage in turning 441 00:58:36.720 --> 00:58:44.380 out capital goods. In fact, the so-called general theory rests on an arbitrary division, 442 00:58:44.380 --> 00:58:50.240 on a Verbal Trick Employment can only increase pari passu, Keynes 443 00:58:50.240 --> 00:58:58.020 contends on page 98, with an increase in investment, unless indeed there is a change in the propensity 444 00:58:58.020 --> 00:59:02.580 to consume. But this is like saying that our combined 445 00:59:02.580 --> 00:59:10.220 supply of ham and eggs can only increase with an increase in our supply of ham, unless indeed 446 00:59:10.220 --> 00:59:40.220 If, in fact, instead of dividing commodities into the two groups, consumption goods and investment goods, we were to divide them, whether consumption goods or investment goods, into two different groups, those whose names begin with the letters from A to M, and those whose names begin with the letters from N to Z, which we shall call the AM commodities and the NZ commodities respectively, 447 00:59:40.220 --> 00:59:45.220 Then, we could arrive at the following Keynesian conclusion. 448 00:59:45.220 --> 00:59:52.220 Employment can only increase pari-passu with an increase in the purchase of the AM commodities, 449 00:59:52.220 --> 00:59:59.220 unless, indeed, there is also an increase in the purchase of the NZ commodities to fill the gap. 450 00:59:59.220 --> 01:00:05.220 Brilliant revolutionary discovery! The New Economics! 451 01:00:05.220 --> 01:00:15.220 But we shall elaborate upon this when we come to Keynes's own elaboration of this basic point in his general theory. 452 01:00:15.220 --> 01:00:19.220 The Sinking Fund Bogie 453 01:00:19.220 --> 01:00:24.220 The next thing Keynes begins to worry about is sinking funds. 454 01:00:24.220 --> 01:00:32.220 Keynes, in fact, worries about practically everything that happens or can happen in a free enterprise system. 455 01:00:32.220 --> 01:00:43.220 His touching faith in the judgment and disinterestedness of government controllers is merely the other side of his distrust of the private businessman. 456 01:00:43.220 --> 01:00:49.220 Take a house which continues to be habitable until it is demolished or abandoned. 457 01:00:49.220 --> 01:00:54.220 If a certain sum is written off its value out of the annual rent paid by the tenants, 458 01:00:54.220 --> 01:01:01.220 which the landlord neither spends on upkeep nor regards as net income available for consumption, 459 01:01:01.220 --> 01:01:06.880 This provision constitutes a drag on employment all through the life of the house, suddenly 460 01:01:06.880 --> 01:01:10.220 made good in a lump when the house has to be rebuilt. 461 01:01:10.220 --> 01:01:15.780 Page 99 Thus, sinking funds, etc., are apt to withdraw 462 01:01:15.780 --> 01:01:21.860 spending power from the consumer long before the demand for expenditure on replacements, 463 01:01:21.860 --> 01:01:28.220 which such provisions are anticipating, comes into play, i.e., they diminish the current 464 01:01:28.220 --> 01:01:51.220 Page 100 465 01:01:51.220 --> 01:01:56.080 Page 100 There are so many things wrong with the foregoing 466 01:01:56.080 --> 01:02:01.420 passage that it is difficult to know where to begin an analysis. 467 01:02:01.420 --> 01:02:06.900 Keynes lumps everything together and does not distinguish between a depreciation allowance 468 01:02:06.900 --> 01:02:13.460 or depreciation reserve, on the one hand, and an actual sinking fund, on the other. 469 01:02:13.460 --> 01:02:20.820 A depreciation allowance or reserve is merely a bookkeeping technique, a convenient accounting 470 01:02:20.820 --> 01:02:30.820 It's primary purpose is to give an entrepreneur a clearer idea of whether he is making a net profit or not, and if so, how much. 471 01:02:30.820 --> 01:02:35.820 A depreciation allowance has no necessary substance. 472 01:02:35.820 --> 01:02:46.820 An actual sinking fund is a fiscal technique and does have substance, but even that almost never exists in the form of unused cash. 473 01:02:46.820 --> 01:02:55.820 It may be invested in long-term bonds of other corporations, or at the very least in short-term government securities. 474 01:02:55.820 --> 01:03:01.820 All but a modest percentage of it will exist, in short, in the form of investments. 475 01:03:01.820 --> 01:03:06.820 Or it may have been used to retire outstanding indebtedness. 476 01:03:06.820 --> 01:03:13.820 When a corporation decides whether or not to abandon an old factory to sell its equipment as scrap 477 01:03:13.820 --> 01:03:22.820 If a plant is to be scrapped or to erect an entirely new plant, its decision will probably be based solely on considerations of profitability. 478 01:03:22.820 --> 01:03:31.820 If continuing to work the old plant or old equipment results in a loss, or in a smaller net profit than a new plant would yield, 479 01:03:31.820 --> 01:03:38.820 or if a new plant, regardless of whether or not the old plant were scrapped, would promise to yield a profit, 480 01:03:38.820 --> 01:03:59.820 Keynes' illustration of a landlord who writes off a certain sum from the value of his house 481 01:03:59.820 --> 01:04:07.220 out of the annual rent, but neither spends that sum on upkeep nor regards it as net income 482 01:04:07.220 --> 01:04:13.380 some available for consumption but then suddenly rebuilds and apparently exactly duplicates 483 01:04:13.380 --> 01:04:19.940 the house in a lump when the house has to be rebuilt is so completely unrealistic that 484 01:04:19.940 --> 01:04:23.420 it hardly deserves serious discussion. 485 01:04:23.420 --> 01:04:29.940 No landlord with a grain of sense leaves his depreciation write-off as idle cash during 486 01:04:29.940 --> 01:04:31.980 the life of the house. 487 01:04:31.980 --> 01:04:39.680 The depreciation allowance in the first place may not even exist as a tangible sum. 488 01:04:39.680 --> 01:04:45.960 Depreciation allowances do not come into existence as tangible sums simply because they are deducted 489 01:04:45.960 --> 01:04:47.800 on the books. 490 01:04:47.800 --> 01:04:54.060 After deduction for depreciation, the landlord of a house or the owner of any other business 491 01:04:54.060 --> 01:04:56.020 may show a loss. 492 01:04:56.020 --> 01:05:01.300 If the loss is as great as the depreciation reserve, then there is no tangible reserve 493 01:05:01.300 --> 01:05:05.700 left to be either spent, invested or hoarded. 494 01:05:05.700 --> 01:05:11.740 If the loss is greater than the depreciation reserve, but if, for the sake of argument, 495 01:05:11.740 --> 01:05:17.740 the depreciation allowance does exist as a tangible fund, then the landlord may either 496 01:05:17.740 --> 01:05:23.680 spend it on his own consumption, he is under no legal compulsion to maintain the value 497 01:05:23.680 --> 01:05:40.480 In any case, he will not leave the money idle, not drawing interest. 498 01:05:40.480 --> 01:05:46.800 But putting aside all these previous objections to Keynes's theories about sinking funds, 499 01:05:46.800 --> 01:05:52.440 what an individual landlord or individual corporation does is not important for the 500 01:05:52.440 --> 01:05:58.040 and the state of employment or industrial activity of the community as a whole. 501 01:05:58.040 --> 01:06:04.960 What is important is only what the actions of landlords and corporations add up to collectively. 502 01:06:04.960 --> 01:06:10.740 In the spectacle of landlords and corporations collectively not putting up any new houses 503 01:06:10.740 --> 01:06:19.460 or factories for twenty or fifty years, say, not from 1910 to 1959, and then suddenly putting 504 01:06:19.460 --> 01:06:26.780 Building them all up in one year, say, 1960, is so absurd that one wonders how it could 505 01:06:26.780 --> 01:06:32.080 be seriously held for five consecutive minutes of thought. 506 01:06:32.080 --> 01:06:39.060 What happens is that each year a certain number of houses, office buildings, factories, machines, 507 01:06:39.060 --> 01:06:43.300 bridges and roads are being built or replaced. 508 01:06:43.300 --> 01:06:49.100 They are being put up or installed regardless of the state of sinking funds, and regardless 509 01:06:49.100 --> 01:07:08.100 are all mainly of the prospects of future profit, but even if the year in which a given structure were replaced were strictly dependent upon the year in which it was built, the replacement year would nevertheless differ with each plant or house, depending on when it was built. 510 01:07:08.100 --> 01:07:14.100 The individual sinking fund periods collectively considered overlap. 511 01:07:14.100 --> 01:07:23.100 Next year, say, Corporation A is lending out its depreciation reserve to help build the new factory of Corporation B. 512 01:07:23.100 --> 01:07:34.100 Next year, Corporation B will be lending out its depreciation reserve money to build the new factory of Corporation C, or even of Corporation A. 513 01:07:34.100 --> 01:07:36.100 And so around the circle. 514 01:07:36.100 --> 01:07:42.340 But Keynes takes his whole preposterous theory so seriously that he virtually attributes 515 01:07:42.340 --> 01:07:46.060 the 1929 depression to it. 516 01:07:46.060 --> 01:07:52.060 In the United States, for example, by 1929 the rapid capital expansion of the previous 517 01:07:52.060 --> 01:07:58.660 five years had led cumulatively to the setting up of sinking funds and depreciation allowances 518 01:07:58.660 --> 01:08:05.260 in respective plant which did not need replacement on so huge a scale that an enormous volume 519 01:08:05.260 --> 01:08:26.260 The aim of entirely new investment was required merely to absorb these financial provisions and it became almost hopeless to find still more new investment on a sufficient scale to provide for such new saving as a wealthy community and full employment would be disposed to set aside. 520 01:08:26.260 --> 01:08:31.260 This factor alone was probably sufficient to cause a slump. 521 01:08:31.260 --> 01:08:33.380 100. 522 01:08:33.380 --> 01:08:39.500 There have been some pretty silly explanations of the 1929 collapse, but it remained for 523 01:08:39.500 --> 01:08:44.940 Keynes to attribute it to the way in which corporations kept their books. 524 01:08:44.940 --> 01:08:50.300 Their new investment or lack of it, their actual amount of physical replacement in any 525 01:08:50.300 --> 01:08:56.300 given year, had in fact nothing to do with these accounting technicalities. 526 01:08:56.300 --> 01:09:02.860 It was determined by the actual physical need for replacement, or rather, more accurately, 527 01:09:02.860 --> 01:09:09.220 by the outlook, as it seemed to the corporation officers or directors, for profits from the 528 01:09:09.220 --> 01:09:11.820 replacement or new investment. 529 01:09:11.820 --> 01:09:18.840 A depreciation allowance may prove in practice to be either too great or too small. 530 01:09:18.840 --> 01:09:24.500 But entrepreneurs are not guided in their present decisions by their past expectations 531 01:09:24.500 --> 01:09:36.060 The drop in new investment was chiefly the consequence of the 1929 slump, not the cause. 532 01:09:36.060 --> 01:09:41.900 But this strange theory about sinking funds enables Keynes to indulge himself once more 533 01:09:41.900 --> 01:09:48.920 in his favorite sport of ridiculing financial prudence and sound finance. 534 01:09:48.920 --> 01:09:53.780 These it turns out are the great enemies of employment. 535 01:09:53.780 --> 01:09:59.300 All prudence will be liable to diminish aggregate demand and thus impair well-being. 536 01:09:59.300 --> 01:10:04.460 The greater, moreover, the consumption for which we have provided in advance, the more 537 01:10:04.460 --> 01:10:09.860 difficult it is to find something further to provide for in advance, and the greater 538 01:10:09.860 --> 01:10:13.820 our dependence on present consumption as a source of demand. 539 01:10:13.820 --> 01:10:20.860 Yet the larger our incomes, the greater, unfortunately, is the margin between our incomes and our 540 01:10:20.860 --> 01:10:21.940 consumption. 541 01:10:21.940 --> 01:10:28.420 So, failing some novel expedient there is, as we shall see, no answer to the riddle except 542 01:10:28.420 --> 01:10:33.980 that there must be sufficient unemployment to keep us so poor that our consumption falls 543 01:10:33.980 --> 01:10:40.180 short of our income by no more than the equivalent of the physical provision for future consumption 544 01:10:40.180 --> 01:10:42.780 which it pays to produce today. 545 01:10:42.780 --> 01:10:45.940 Page 105 546 01:10:45.940 --> 01:10:49.220 In a Nutshell 547 01:10:49.220 --> 01:10:55.500 Here is the general theory in a nutshell, with its transvaluation of all values. 548 01:10:55.500 --> 01:11:00.580 The great virtue is consumption, extravagance, improvidence. 549 01:11:00.580 --> 01:11:05.420 The great vice is saving, thrift, financial prudence. 550 01:11:05.420 --> 01:11:11.220 We shall reserve to a later point an exposition of why Keynes's riddle is a riddle of his 551 01:11:11.220 --> 01:11:16.220 own imagination, not of the free enterprise economic system. 552 01:11:16.220 --> 01:11:21.960 And we may anticipate one of our chief criticisms here by calling attention to Keynes's crude 553 01:11:21.960 --> 01:11:29.620 and naive conceptions of consumption and investment purely in quantitative terms, whereas every 554 01:11:29.620 --> 01:11:36.080 civilized human being in his actual consumption and use of capital equipment concedes them 555 01:11:36.080 --> 01:11:39.420 just as much in qualitative terms. 556 01:11:39.420 --> 01:11:45.580 There are definite limits, of course, to the quantitative use or consumption of food, clothing, 557 01:11:45.580 --> 01:11:51.580 Housing and Capital Equipment, but there are no assignable limits to possible improvements 558 01:11:51.580 --> 01:11:57.060 in the quality of capital equipment and in the products and services that it can help 559 01:11:57.060 --> 01:11:58.060 to produce.