There are some simple ideas that are central to a lot of economics.
One of them is “The Marginal Propensity To Invest”.
It isn’t a particularly rare term. A google on it gives “About 849,000 results” (not too bad for a small corner case of The Dismal Science).
It basically says that as income increases, we invest more of our income. Pretty simple, really. If you are starving, you will spend all you have on food, and then some. As you move to ‘lower middle class’, you will put a bit into savings. Maybe in a jar in the closet, maybe in a bank (where ‘intermediation’ can move it into investments as loans are made – so sometimes ‘marginal propensity to invest’ is treated as the related concept ‘marginal propensity to save’, which gets “About 656,000 results” including the wiki). Sometimes we turn our savings into direct investments (taking a leap and buying that franchise…). As you reach the rich and super rich, most of their money goes into investments. Stocks, bonds, direct investments. You name it. It’s hard to eat a $Billion, so most of it gets invested.
The result is a graph that rises as incomes rise. An example is here:
The change in business investment expenditures induced by a change in income or production (national income or gross domestic product). The marginal propensity to invest (abbreviated MPI) is another term for the slope of the investment line and is calculated as the change in investment divided by the change in income or production.
The surprising thing is that a search on “propensity to invest wiki” does not find a wiki. All they have is a ‘save’ version, and it’s pretty darned poor:
So small that I’m going to quote the whole thing here:
Marginal propensity to save
The marginal propensity to save (MPS) refers to the increase in saving (non-purchase of current goods and services) that results from an increase in income. For example, if a household earns one extra dollar, and the marginal propensity to save is 0.35, then of that dollar, the household will spend 65 cents and save 35 cents. It can also go the other way, referring to the decrease in saving that results from a decrease in income. It is crucial to Keynesian economics and is the key variable in determining the value of the multiplier.
Mathematically, the marginal propensity to save (MPS) function is expressed as the derivative of the savings (S) function with respect to disposable income (Y).
In other words, the marginal propensity to save is measured as the ratio of the change in saving to the change in income, thus giving us a figure between 0 and 1. It is the opposite of the marginal propensity to consume (MPC). In a two sector closed economy MPS = 1 – MPC. Then for the example above, the marginal propensity to consume would be 0.65.
Notice the complete lack of anything linking the concept of 'saving' with 'investing'… We don't need any of those evil dirty investors in the Wiki View of Economics….
I can’t help but wonder if this is an indication of a socialist bias in the Wiki collective Point Of View as they see no need for ‘investing’… Yes, it could simply be an odd omission. I doubt it, though.
Why this matters
I’d planned to just do a quick posting on why “Rich People Are Good”, even though I’m not one. The thesis is pretty simple.
Investment over time drives economic growth.
Economic growth lifts all boats and we all gain from the economic improvement.
Therefor more investment is better.
To get more investment, you need more folks investing more money.
That means either more folks entering the “richer” classes or richer folks getting richer.
So: If you want a better aggregate economic performance, you need more rich folks (or higher concentration of wealth).
What is the socialist mantra and class warfare all about? Concentration of wealth is evil and we need ‘economic justice’ which means taxing the 1% and giving it to the 99% as government goodies.
Yet the Marginal Propensity To Invest tells us that doing this will result in greater poverty as economic growth reduces (and eventually stagnates or reverses).
Do I like this? No, not at all.
I’m as attracted to the Socialist Equality Ideal as anyone else. Even the Catholic Church has come out in favor of wealth redistribution and ‘redistributive justice’. The attack on the rich is in full force, with everyone from Occupy Wall Street to the Pope on the bandwagon. It’s an attractive meme. Make those wealthy suckers pay!
I know about the Marginal Propensity To Invest. And my reason triumphs over my desire.
If we tax those rich folks and take their wealth, if we let our envy and greed dominate our reason, we will have either fewer rich folks or poorer rich folks. That, inevitably, means a lower aggregate Propensity To Invest. A weaker economy. Fewer jobs, and stagnation or recession (in the extreme case).
It’s really pretty simple. Poor folks eat their seed corn. Rich folks save more of it and plant more acres next year. Which one gives you more to eat in future years?
Sometimes The Dismal Science can be a real bitch. (And no, you can’t change the truth in it via passing legislation…)
Socialism and Investment
In the Socialist model, The State does the ‘investing’. It builds the factories and does the job creation. It is The Rich Guy. Only one is needed, and it is The State. (That socialists are happy with ONE Monopolistic Rich Guy, the government, while railing against a competitive landscape of capitalist Rich Guys has often caused me to ponder their thinking processes… Monopolies are evil, so they want to fix it with a single Super Monopoly? Go figure…) So in discussing socialist banking one often hears about ‘savings’ of the common man; investing not so much… As that is a the province of The State.
And that is why the lack of a ‘propensity to invest’ on the Wiki causes me just a momentary doubt about their POV and what bias it might have (intentional or accidental).
But, back at ‘propensity to invest’:
In Greece and in Italy right now we have a large ‘propensity to consume’ and not enough ‘propensity to invest’. They are living off of the collective ‘savings’ of the German people and looking for more folks to pony up some ‘savings’ to be used for Greek and Italian consumption. Notice what’s missing in that? Savings are NOT going into investment that will create greater future productivity (and thus more future wealth so the existing savings / wealth can be paid back with some gain / interest). Turning savings into consumption will, inevitably, result in LESS economic productivity over time, less wealth, more poverty, and collapse of the economy leading to collapse of the country(s) involved in the extreme end case.
The root cause being a reduction in “propensity to invest” in favor of “propensity to consume”. Even capturing Other People’s ‘savings’ and turning it into consumption and an I.O.U. that will never be payable (as there is no wealth created from productive investments from which to pay it.)
“Why?” is an interesting question that I’m mostly going to dodge.
(As it’s a book or two ;-) But at the core is a Socialist emphasis on ‘spreading the wealth’ that results in too little investment and too much consumption. Spreading the wealth inevitably causes lower investment and increased poverty; just sometimes it can take a generation to show up.
What To Do?
Well, first off, recognize the core cause. The problem is too little propensity to invest and too much propensity to consume.
Second, recognize that the solution is two fold. Part A: Less consumption. (Often called ‘austerity measures’ when applied at the country level by the IMF – International Monetary Fund). Part B: More investment.
And it’s that second part that causes the larger grief.
You will hear a lot of politicians, on both sides of the ocean, talking about “investment”. By this they usually mean “handouts to my favored friends and consumption by voters.” So we get “investment in education” that often means “grants to young student voters and higher payrolls to liberal college professors”. That money gets consumed, not invested. There IS an educational byproduct, but it isn’t all that much. (“Black Studies”, “Sociology”, “English Lit.” etc. are widely taught and do NOT result in a whole lot more economic product, either for society or for the students. They are more ‘entertainment consumption’ than actual economic investment.)
Even “Physics” doesn’t yield all that much in the way of economic increase. Who employs Theoretical Physics PhDs? Well, schools and weapons programs and ??? Yeah, some get employed as ‘sort of an Engineer’ in private industry, but they would be more economically productive AS engineers. So even then there is an efficiency loss of personal interest beating out investment…) “Investment in infrastructure” often means “payments to Unions for folks to lean on shovels” as we dig up one road and put a new one it its place, or hand large payments to friends of the government for “studies” with little work product delivered. Sometime it means money handed out to folks to influence the political process or move a social agenda (viz Acorn). Hardly an economic investment that increases production of goods. As ‘what is a service’ is highly debatable, these things are often called ‘services’ so as to hide the actual political aspect.
Private industry is much more efficient at actual investment. Among other things, they actually expect a net increase in wealth at the end of the process or they go out of business. So when a PhD Physics gets a job in private industry R&D, it tends to be focused on things like making better optical fibers or finding oil and less on things like String Theory and quantum mechanics. That is, the ‘investment’ is more of an investment and less of an entertainment charge.
FWIW, I’m all in favor of spending on things that are fun, interesting, entertaining, and generally improve knowledge even if that knowledge is not particularly economically beneficial. Just don’t call it “investment”. It isn’t. It’s Patronage or it’s entertainment or it’s just curiosity, but it isn’t investment and we don’t have more wealth at the the end of it, we have less. Modulo the sporadic side bar when someone takes bit of theoretical physics and figures out how to do engineering things with it… In essence, I’m all in favor of Shakespeare Plays, just don’t call them an ‘investment’. They are a highly valuable form of consumption. Like a fine wine or a great prime rib dinner. Well worth having, but not creating more wealth when done with the consumption.
The consequence of these things is pretty simple:
We need MORE rich folks, not less. We need to let them keep their money, not take it away. We need to get the government out of the business of picking winners and losers and very much out of making “investments” as they don’t even know what it really is.
Do I like that? No, not at all. I’d rather have about $100,000 of Bill Gates money given to me as an ‘investment’ in my personal development… But I don’t need to like something to know that its good for me.
That is a lesson that Greece and Italy have yet to learn.
Now if I can just find a way to become one of those Rich Guys with a high Propensity To Invest, I promise to spend all my time creating more excess wealth to invest even further in new wealth creating enterprises; even if I have to hire a bunch of folks to leverage my time and money in the process. ;-)