I know nothing about economics. Recently, I have been reading Robert Murphy's 'Lessons for the Young Economist,' and I don't really understand Chapter Ten, where he writes,
"The essential insight is that a sudden increase in savings allows the economy’s output to shift away from consumption goods and into capital goods. Just as Robinson Crusoe was able to enhance the power of his bare hands through the wise use of saving and investment—even though he had nobody to “lend to” on the island—so too can the whole population enhance each other’s labor productivity by channeling more resources into the production of machinery and tools. There is no “cheating” going on here; everyone’s income can grow larger over the years when everyone is more physically productive because of the growing stockpile of capital goods."
I don't really understand what he's trying to insinuate here. Is he saying that if everyone worked to create tools that could be used to make more tools, it would create opportunities for everybody? I'd like a clarification on this, because I'm afraid that I've missed the whole point.
"I don't really understand what he's trying to insinuate here. Is he saying that if everyone worked to create tools that could be used to make more tools, it would create opportunities for everybody? I'd like a clarification on this, because I'm afraid that I've missed the whole point."
He is saying you can't do both with the same resources. Whatever you spend on consumer goods can't be used to fund the production of capital goods, and vice versa. Making more 'tools' to increase the productivity of the workforce isn't a good thing in and of itself, and doesn't lead to more wealth, unless it's the result of a voluntary shift of resources in that direction and away from consumption. So, if people decide they're going to buy less now and save more, there's more available to fund those longer term, productivity enhancing projects that increase wealth. And if that happens then the ultimate result is more 'stuff' being produced for the same amount of resources, which means falling real prices and greater access to that 'stuff' for all. And the stuff could be anything from food to cars to watches to stereos.
So, producing more for a given input of resources is the way to wealth, and the only way to do that in a sustainable fashion is if people tend more toward abstaining from instant gratification and making more resources available in the form of savings to fund longer term projects.
He is saying that there are generally two scenarios in an economy: a time for consuming and a time for saving. When we consume, we spend our money 'quickly' from the time that we earn that money. When we save, we 'hoard' our money in banks. When the banks have more money, because of our saving practices, they are able to lend money to people who want to use it. As the supply of money goes up in the banks, the price for it over time goes down (low interest rates), and the low interest rate makes it attractive for long-term production processes to occur.
Murphy is also trying to get across that long-term production processes generally shouldn't be invested in during a consumption phase, because the banks have less money to lend, and therefore a higher price to lend that money (higher interest rates). If we want to economize our money practices, we want the highest profit to loss ratio we can get, and that is possible if we invest when the price to invest is the least costly.
I think I get it now.
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