The “Paradox” of Saving Part 1

The “Paradox” of Saving Part 1
Profile photo of F.A. Hayek

checkThis essay originally appeared in the Zeitschrift für Nationalökonomie, Bd. I, Heft III, 1929, under the title “Gibt es einen Widersinn des Sparens?” The first English translation appeared in Economica, May, 1931.1 Reprinted from

i – Introduction

The assertion that saving renders the purchasing power of the consumer insufficient to take up the volume of current production, although made more often by members of the lay public than by professional economists, is almost as old as the science of political economy itself. The question of the utility of “unproductive” expenditure was first raised by the mercantilists, who were thinking chiefly of luxury expenditure.

The idea recurs in those writings of Lauderdale and Malthus that gave rise to the celebrated Théorie des Débouchés of James Mill and J.B. Say, and, in spite of many attempts to refute it, it permeates the main doctrines of socialist economics right up to T. Veblen, and Mr. J.A. Hobson.

But while in this way the idea has found a greater popularity in quasi-scientific and propagandist literature than perhaps any other economic doctrine hitherto, fortunately it has not succeeded as yet in depriving saving of its general respectability, and we have yet to learn that any of the numerous monetary measures intended to counteract its supposedly harmful effects have been put into practice. On the contrary, we have recently witnessed the edifying spectacle of a “World Saving Day,” on which central bank governors and ministers of finance vied with each other in attempting to disseminate the virtue of saving as widely as possible throughout their respective nations. And even though there are those who demand an increase in the currency on the grounds that there is an increased tendency to save, it is hard to believe that the presidents of central banks at any rate will prove very ready listeners.

This state of affairs, however, may yet be endangered by a new theory of underconsumption now current in the United States and in England. Its authors are people who spare neither money nor time in the propagation of their ideas. Their doctrine is no less fallacious than all the previous theories of underconsumption, but it is not impossible that with able exposition and extensive financial backing it may exert a certain influence on policy in Anglo-Saxon countries. For this reason it seems worthwhile subjecting this theory to detailed and exhaustive criticism.

ii – Foster and Catchings

The teachings of Messrs. Foster and Catchings, with which I am primarily concerned in this study, attained their widest circulation in the United States where they have achieved considerable repute not only among members of the public, but also among professional economists. To understand this success it is necessary to know something of the background of the theory and the very able means by which it has been and still is being propagated. Quite apart from its analytical significance, for European observers at any rate, the story has a certain spectacular interest. I propose, therefore, to deal with it at some length.

Let us start with the two authors. The history of their joint careers provides certain points that give a clue to the origin of their teaching. Waddill Catchings was born in the south; he had a successful career as a lawyer and banker, finally reaching a high position in the iron and steel industry. In 1920 he, and a number of fellow-students from Harvard, decided to commemorate a deceased friend. For this purpose they founded the “Pollak Foundation for Economic Research.” They appointed as director another Harvard friend, William Trufant Foster, a pedagogue, at one time a college president. The Foundation had an annual income of $25,000 and it soon began to be responsible for the publication of important books on economic subjects, some of them by well-known economists, such as Irving Fisher’s Making of Index Numbers, others by members of the Foundation, such as A.B. Hasting’s Costs and Profits, and, above all, Money by Messrs. Foster and Catchings themselves. In this latter work, although it is primarily a very able and instructive exposition of the theory of money, the authors laid the basis of their theory of trade depression later to be fully expounded in their work on Profits. In Money,they emphasize especially those parts dealing with the circulation of money and the effects on markets of changes in the rate of flow of money. After describing how circulation starts from the market for consumption goods, from which it passes into the market for production goods, and finally returns to its original source, they discuss the conditions under which this process creates a steady demand for the goods offered for sale, and the factors which influence the circulation of money either by accelerating or retarding it. While, in a barter economy, supply and demand are necessarily identical, the appearance of money is shown to be capable of disturbing this equilibrium, since it is only possible to maintain production at the existing level if the producers spend money at the same rate as that at which they receive it. Thus the circulation of money between the various stages of the economic process becomes the central problem of all investigation, not only of changes in the value of money, but also of the influences affecting cyclical fluctuations.

Indeed they even go so far as to lay it down that: “Money spent in the consumption of commodities is the force that moves all the wheels of industry. When this force remains in the right relation to the volume of commodities offered for sale, business proceeds steadily. When money is spent faster than the commodities reach the retail markets, business booms forward. When commodities continue to reach the retail markets faster than money is spent, business slackens. To move commodities year after year without disturbing business, enough money must be spent by consumers, and no more than enough, to match all the commodities, dollar for dollar.”2

It is this theory which forms the basis of the trade cycle theory, which is set forth in great detail in Profits,3  published three years later. In this voluminous work, with which we shall be concerned in the next sections, Messrs. Foster and Catchings give the most elaborate and careful exposition of their theory. But, despite the clear and entertaining exposition, it failed to secure for the theory the wide circulation desired by its authors. They proceeded, therefore, to restate the main principles in popular language, first in their Business without a Buyer,4  and later in abridged form in an essay in the Atlantic Monthly, which was distributed freely as a reprint in hundreds of thousands of copies.5  Most effective, however, in advertising their ideas was the peculiar competition held in connection with the publication of Profits. By offering a prize of $5,000 for the best adverse criticism of the theory contained in this work, the promoters invited the whole world to refute them. But before dealing with the results of this competition it is necessary to consider the general principles of their work.

iii – Enough Money in the Hands of Consumers

The theory of crises advanced by Messrs. Foster and Catchings in Profits is preceded by a detailed explanation of the organization of the present economic structure. This justification of the existing “Money and Profit System,” as it is called by the authors, fills about one-half of the volume of four hundred pages. For our purpose, it is sufficient to mention that in this part the function of entrepreneur’s profit as a factor determining the direction and extent of production is investigated; but it is worth remarking even at this juncture that the authors succeed in completing this investigation without at any point making clear the real function of capital as a factor of production. Our main concern in this article, however, is confined to the fifth and last part ofProfits which deals with “Money and Profits in Relation to Consumption,” and which, according to the authors themselves, represents a more or less independent object for critical study.  It will be necessary in this connection also to refer in some detail to the short essay entitled The Dilemma of Thrift.6

The main thesis of the book is stated as follows: “The one thing that is needed above all others to sustain a forward movement of business is enough money in the hands of consumers.”7  Now in the present state of affairs a situation arises from time to time when the buying power in the hands of the consumers is insufficient to purchase the whole industrial output at prices that cover costs. The consequent diminution in sales in the market for consumption goods results in unemployment of factories and plant, that is to say, in crises and trade depressions. The question is: where does the deficit in the consumers’ income originate? The earlier exposition in Money and Profits affords no explanation of this phenomenon, since it does not take into account the three principle factors upon which the velocity of circulation, and therefore the “annual production-consumption equation” depend, i.e., the influence of saving, of profits, and of changes in the volume of currency. The most important of these factors is saving, both individual and corporate. To elucidate this point the authors proceed to examine a series of numerical examples and, in the course of this examination, they introduce a number of fictitious assumptions, which, as we shall see later, have an important bearing upon their conclusions. They assume, that by a process of vertical and horizontal integration, the whole industry of the isolated country considered has been united into one single enterprise, payments from which in the form of wages, dividends and salaries form the only source of the community’s income. (There are no taxes or government expenditure of any kind.) It is assumed further that the price level, the volume of currency, and the velocity of circulation remain constant, and that wages are received and spent during the same economic period in which the goods are manufactured, while these goods are only sold in the following period, and the profits earned on them are also distributed and spent by the recipients during this same period.8

With the aid of numerical examples of this sort, the authors demonstrate that, under these conditions, there can be no difficulty in selling the goods manufactured, either in the case of a constant volume of production or of a rising volume per wage unit, so long as “industry continues to return to consumers in some way all the money that it took from consumers in the sales price of its product, and as long as consumers spend all that they receive.”9  But as soon as the company retains part of the profits in the business, not for the purpose of carrying larger stocks, financing the sale of an increased product, or in unsuccessful attempts to improve equipment — for these things are comparatively harmless — but in order to improve “capital facilities,” which puts it in the position to increase the volume of production, this happy state of affairs changes. As soon as the increased volume of products reaches the market, it is inevitable that the means of payment in the hands of the consumer should prove insufficient to take up the product at remunerative prices. So long as the process of investment is going on no difficulty arises, since the rise in the total wage bill resulting from the increased number of workmen necessary to carry out the extension equals the loss in the shareholders’ income resulting from the reduction in dividends, and thus the relation between the volume of production and the money spent on it remains unaltered. The crisis sets in with the appearance on the market of the surplus output. The money in the hands of the consumer does not increase any further (the sums necessary for the extension of production having already been spent by the wage earners in the previous period to take up the smaller volume) and, since it is assumed that there is no fall in prices, a proportion of the enlarged product must therefore remain unsold.

In The Dilemma of Thrift, Messrs. Foster and Catchings provide the following description of the events leading up to this crisis:10  “Suppose, however, it [the corporation] uses the remaining one million dollars of profits to build additional cars, in such a way that all this money goes directly or indirectly to consumers. The company has now disbursed exactly enough money to cover the full sales-price of the cars it has already marketed; but where are the consumers to obtain enough money to buy the additional cars? The corporation has given them nothing with which to buy these cars.” The new cars, therefore, must remain unsold, “unless the deficiency [in consumers’ income] is made up from outside sources.”11

According to Messrs. Foster and Catchings the significant difference between the money spent upon consumption goods and money invested rests upon the fact that money of the former kind is “used first to take away consumers’ goods, whereas in many cases money invested is used first to produce more consumers’ goods.”12

Money that is once used to bring about the production of goods is again used to bring about the production of goods, before it is used to bring about the consumption of goods. In other words, it is used twice in succession to create supply; whereas if the $100,000 in question, instead of having been invested in the production of additional goods, had been paid out as dividends and spent by the recipients, the $100,000 would have been used alternately to bring goods to the markets and to take goods off the markets.13

Statements of this sort, which are repeatedly used by the authors, have led so acute a thinker as Mr. D.H. Robertson to remark that he could not attach any sense to them whatever.14  It therefore seems worthwhile attempting to restate this part of the theory in more familiar language. Granting the initial presuppositions of the authors, it is, I think, unassailable. So long as the total disbursements during the course of production are spent on consumption goods, the expenses of production are necessarily equal to the proceeds of the sale of the goods purchased. If, however, certain amounts, such as interest earned on capital, or profit, which could be spent on consumption goods without reducing the existing capital stock, are applied to purchasing additional means of production, the sum total spent on production rises without being accompanied by an equivalent increase in the sums available to buy the final product. It is in this “short circuit” in the circulation of money, as Mr. P.W. Martin,15 whose ideas are closely related to those of Messrs. Foster and Catchings, describes it, that we find the alleged cause of the deficiency in the buying power of the consumer.

Now since the results of corporate saving and of individual saving must be alike, since individuals as well as corporations must save if they are to progress, but since, if this theory is correct, they cannot save at present without frustrating to a certain extent the social purpose of saving, the Dilemma of Thrift is inescapable.

From the standpoint of society, therefore, it is impossible to save intelligently without first solving the problem of adequate consumer income. As it is to-day, certain individuals can save at the expense of other individuals; certain corporations can save at the expense of other corporations; and, from the standpoint of the individual and of the corporation, these savings are real. But society as a whole cannot save anything worth saving at the expense of consumers as a whole, for the capacity of consumers to benefit by what is saved is the sole test of its worth.16

After the main thesis of the theory has thus been expounded, the authors drop a number of artificial assumptions and attempt to bring the theory nearer to reality. The first assumption to be abandoned is that of a stable price level (this assumption, by the way, was never consistent with their other assumptions). They then examine the effects of falling prices, which alone make it possible to sell the whole of the enlarged product. But falling prices, they argue, make it impossible for industry to maintain production at the new level. The fall of prices causes profits to disappear, and with profits every incentive to the continuation of production.17  Moreover, it is argued, it is a matter of experience that falling prices render an extension of production impossible. “If there is any fact concerning which our statistical evidence fully supports our reasoning, it is the fact that falling prices put a damper on productive activity.”18  Only on paper is it possible, in spite of falling prices, to carry out productive extensions by means of falling costs, because only on paper can you regulate the diminution of cost so that even the enlarged product can be sold with sufficient profits. In the existing economic system, with the many independent units composing it, such a development is not to be expected. On the contrary, we should rather expect price movements in the wrong direction. A fall in the price of consumption goods, therefore, must always bring about a diminution of production.19

Having thus attempted to show that a general fall in prices can never bring about a solution of the problem, the authors next proceed to consider changes in the volume of money. After all that has been said, it is argued, it should be clear that even changes in the volume of money can only solve the problem in so far as they influence the “production-consumption equation.”

It is not sufficient for this purpose that the total volume of money be increased. The money must go into circulation in such a way that the flow of new money into the hands of the consumers is equal in value, at the current retail price-level, to the flow of new goods into consumers’ markets. The question is not, then, whether currency or bank-credit, or both, should be increased year after year, but in what way the new money should be introduced into the circuit flow.20

Now unhappily, under the existing system of money and credit, additional money gets into circulation, not on the side of the consumers but on the side of the producers, and thus only aggravates the evil of the discrepancy between producers’ disbursements and consumers’ money expenditure. Moreover, this system of increasing the money supply through productive credits has the further effect that additions to the money supply take place when they are least necessary. The extension of production that they finance is a response to a lively demand. But when a falling off of consumers’ demand is noticeable then credit is restricted and the trouble is aggravated. Thus the modern claim to restrict credit at the first sign of increasing warehouse stocks, and vice versa, is thoroughly pernicious.

In this way … every advance towards higher standards of living would promptly be checked; for whenever it appeared that consumer income was too small, it would be made smaller still through wage reductions, and under-production would follow promptly.21

Nevertheless, it would be easy to arrange an increase in consumers’ credits, and it is only in this way that the deficiency in the purchasing power of the consumer, and thus the cause of the depression, can be removed.

Theoretically, then, it is always possible to add to the money circulation in such a way as to benefit the community. … In any conceivable situation … an all-wise despot could make a net gain to the community by increasing the volume of money in circulation. … If any safe and practicable means could be devised, in connection with increased public works and decreased taxes, or in any other connection, of issuing just enough money to consumers to provide for individual savings and to enable them to buy an enlarged output, and business men were confident that issues to consumers would continue at this rate and at no other rate, there would be no drop in the price-level and no reason for curtailing production, but, on the contrary, the most powerful incentive for increasing production.22

In Profits, the authors do not go further than to hint at these proposals. After a not very successful attempt at statistical verification they conclude that, under the present order of things, every attempt at increasing production must be checked by the fact that the demand of the consumer cannot keep pace with the supply. To remove the causes of this underconsumption is one of the most promising and most urgent problems for the present generation. “Indeed, it is doubtful whether any other way of helping humanity holds out such large immediate possibilities.”23

But before such reforms can be achieved, professional economists will have to admit the inadequacy of their present theories. “If the main contentions of Money and Profits are sound, much of our traditional economic teaching is unsound, and overlooks some of the fundamentals which must be better understood before it willbe possible to solve the economic problem.”24  Conversion of professional economists was therefore the main purpose of the campaign that was launched by offering a prize for the best adverse criticism of Profits.

iv – Objections that Miss the Point

The result of this competition for the best adverse criticism of their theory was the most remarkable success achieved by Messrs. Foster and Catchings. The three members of the jury, Professor Wesley C. Mitchell, the late Allyn A. Young, and Mr. Owen D. Young, the President of the General Electric Company, of “Young Plan” fame, had no less than four hundred and thirty-five essays to examine. In the introduction to the little volume in which the prize essay and others were published,25  Messrs. Foster and Catchings relate, with some pride, that at least fifty universities, forty-two American States, and twenty-five foreign countries were represented. Among the authors were at least forty authors of books on economics, fifty professors of political economy, sixty accounting experts, bankers, editors, statisticians, directors of large companies, etc. — among them “some of the ablest men in the Federal Reserve System,” a functionary of the American Economic Association, a former President of that Society, and “several of the most highly-reputed economists in the British Empire.”

But despite this highly respectable mass attack of adverse criticism, Messrs. Foster and Catchings remained convinced that their theory still held its own. Moreover, they were able to quote the opinion of one of the umpires,26 that notwithstanding all that had been said against it, the substance of the theory remained untouched. This sounds extraordinary. But what is more extraordinary is that a candid perusal of the various criticisms that have been published forces one to admit that it is true. So far, the main theory, and what in my opinion is the fundamental misconception of Messrs. Foster and Catchings, has remained unanswered. The meritorious and readable works that were published in the Prize Essays, equally with criticisms published elsewhere,27  direct their criticism only against details. They accept the main thesis of Messrs. Foster and Catchings. Only the two essays of Novogilov and Adams, which we shall have occasion to mention later on, touch upon the critical points, and even here they do not make their respective objections the basic part of their criticism, or develop them into an independent refutation.

In the case of Novogilov’s work, it is possible that this is an injustice. In the Prize Essays it was only published in abridged form, and just the part dealing with the influence of varying quantities of product at the various stages of production on the level of profits was entirely left out.28  It is to be hoped that one day it will be published in its entirety. Mr. A.B. Adams’s essay, on the other hand, whose criticism on many points coincides with that developed in this essay, and which in an incidental remark foreshadows one of its main theses,29  suffers from the fact that the author himself does not realize the full importance of his objections, and therefore only criticizes the application of Messrs. Foster and Catchings’s theory to the case of investment in fixed capital, while admitting its correctness in the case of investment in circulating capital. But even Mr. Adams seems insufficiently to appreciate the function of capital and the conditions determining its utilization — a deficiency that is common both to the authors of the theory and to all their critics.

As for the rest, they all endeavor to prove that the existing currency organization suffices to increase the supply of money in the course of an extension of production so as to avoid a fall in the price level. Some of them also point out that the extension of production can also bring about a diminution in costs per unit, so that falling prices need not always put a damper on production. But the alleged necessity to ease the sale of the enlarged product by an increase in the money supply is, in general, allowed to pass unquestioned. In doing this, however, the critics place themselves in a difficult position. For the contention of Messrs. Foster and Catchings that productive credits aggravate still more the deficiency in the purchasing power of the consumer is clearly a corollary of the fundamental concept on which the claim for increasing the volume of money by productive extensions is based. To meet this difficulty the critics resort to various expedients. Some make very ingenious investigations into the order of succession of various money movements. Some attempt to refute the rather shaky assumptions in regard to the formation of profits in the course of productive extensions. Correct as these objections may be, they miss the point. The main thesis remains untouched.

v – The Road to Plenty

It is clear that this is the opinion of Messrs. Foster and Catchings, for in their Business without a Buyer, published after the close of the prize competition, they do not make any significant alterations in the exposition of their theory. Fortified by the result of the competition, they then proceeded to develop the practical consequences of their theory. In The Road to Plenty,30 which embodies the results of these further reflections, they make no attempt to appeal to economists. Despite the extremely favorable reception of their former books, it appears they are far from satisfied with professional economists. Both in the introduction to the Prize Essays and inBusiness without a Buyer they dwelt with some sprightliness on the lack of enlightenment in such circles. Now they turn to the general public and cast their theory in the form of a novel. The book records a conversation in the smoking compartment of a train where the complaints of a warm-hearted friend of humanity cause a genial business man to explain the causes of crises and unemployment according to the theory of the authors, and then to defend the latter against the objections of a solicitor and a professor of economics (who, of course, comes out worst). Finally, all those present (including a member of the House of Representatives) are roused to a great pitch of enthusiasm about the concrete proposals based upon it.

These proposals are formulated still more clearly in a further essay, Progress and Plenty,31  and before proceeding to examine the theory it is worthwhile setting them forth explicitly. The first demand of the authors, and the condition for the execution of their further proposals, is an extension of business statistics in the direction of a more exact knowledge of the sales of consumption goods — in the first place, a complete and reliable index of retail prices; secondly, statistics of all factors influencing these prices (i.e., all possible economic data). These should be collected by public authorities and published promptly, in order to give information and orientation to the business world. On the basis of such statistics, all public works and all financial operations of the Government should be directed in such a way as to even out fluctuations in the demand for consumption goods. In Progress and Plenty,32  Messrs. Foster and Catchings recommend the delegation of the business of collecting data, and their application to the distribution of public works to a separate body, the “Federal Budget Board.” Just as the Federal Reserve Board directs a system for the financing of production, the Federal Budget Board should direct the financing of consumption and prevent disturbances of the economic system arising from consumption lagging behind production.

So far, apart from the demand for a new Board, the proposal contains nothing beyond the much-discussed plan for distributing public works in time in such a way as to concentrate all those capable of being postponed to times of depression. But Messrs. Foster and Catchings are not satisfied with this. They realize that such a plan would have undesirable effects if the necessary sums were collected and locked up in the public Treasury in times of prosperity and spent in case of need. On the other hand, to raise the money by taxation at the time when it is needed for public works would be still less likely to achieve the desired end. Only an increase in the volume of money for the purpose of consumption can solve the problem:

Progress requires a constant flow of new money to consumers. If, therefore, business indexes show the need for a reinforced consumer demand which cannot be met without additional Government expenditure, the Board should bring about such expenditure, not only out of funds previously accumulated for that purpose, but at times out of loans which involve an expansion of bank credit. This feature of the plan is essential.33  It follows that the Government should borrow and spend the money whenever the indexes show that the needed flow of money will not come from other sources.34

As might be expected, the authors protest35  that all this is not to be regarded as inflationary. Before its publication they had promised that it should contain “nothing dangerous or even distasteful,” and that it would not involve “unlimited issues of fiat money.”36  We shall deal critically, with these proposals in the last section of this article. At present, it need only be remarked that even critics who sympathize with Messrs. Foster and Catchings’s theory have been unable to conceal their scruples on this point. Mr. D.H. Robertson37  remarks very correctly that he has no doubts that they were born with a double dose of the inflation bacillus in their composition; and though they have done their best to exorcise it with prayer and fasting, so that they are able to look down with detached pity on more gravely affected sufferers, such as Major Douglas, yet at critical moments the bacillus is always apt to take charge of the argument.

It is, therefore, all the more astounding that they are able to quote in the advertisements to The Road to Plenty(it is true without mentioning the source) the opinion of no less an authority than the late Professor A.A. Young, that “on economic grounds, the plan for prosperity” proposed in The Road to Plenty “is soundly conceived,” and that (according to the same source) Mr. W.M. Persons should have thought the plan “practicable and important.”

In wider circles, the proposals of Messrs. Foster and Catchings seem to have had an extraordinary effect. President Hoover’s pledge to carry out, within practical limits, such a regulation of public works as would alleviate unemployment, has been a powerful lever to their argument. In a recent pamphlet38  they announce that Senator Wagner from New York has already brought a bill before Congress for creating a “Federal Unemployment Stabilization Board” with very similar functions to their “Federal Budget Board.” So far it has not been proposed that this Board should finance public works with additional bank money, and even Messrs. Foster and Catchings have guarded themselves from demanding the execution of this part of their proposals — even in connection with the Hoover Plans. Instead they have concentrated on a criticism of the policy of the Federal Reserve Board in raising its discount rate at a time of falling prices and falling employment.39  It is pressure of this sort that constitutes a danger both in America and elsewhere if such theories gain further popularity. At this point, therefore, we may pass to a criticism of their validity.

vi – A Complete Misunderstanding of the Function of Capital

It is constantly assumed by Messrs. Foster and Catchings that the investment of savings for the extension of production necessarily increases the total costs of production by the full amount of the invested savings. This follows clearly from their continual emphasis on the “fact” that the value of the increased product is raised by the amount invested, and that therefore it can only be sold profitably for a proportionately higher sum. It is implied by the examples, in which it is always assumed that the increase in the current outlay in wages, etc., exactly corresponds with the sums invested. Now there is a certain initial obscurity in this assumption, since it is obvious that the costs of the product produced during an economic period cannot rise by the whole of the newly invested sum if this is invested in durable instruments, but only in proportion to the depreciation of the new durable capital goods; a fact that is not made clear in their exposition. My main objection, however, is not concerned with this circumstance — which it is impossible to believe that the authors could entirely overlook — but rather with their assumption that generally, over any length of time, the costs of production can increase by the whole of the newly invested amount. This view, which is based on a complete misunderstanding of the function of capital as a “carrying” agent, assumes that the increased volume of production brought about by the new investments must be undertaken with the same methods as the smaller volume produced before the new movement took place. Such an assumption may be true for a single enterprise, but never for industry as a whole. For in industry as a whole an increase in the available supply of capital always necessitates a change in the methods of production in the sense of a transition to more capitalistic, more “roundabout,” processes.

For in order that there may be an increase in the volume of production without a change in the methods of production, not only the available supply of capital, but also the supply of all other factors of production must be increased in similar proportion. In regard to land, at any rate, this is practically impossible. It is just as inadmissible to assume that the complementary factors that are necessary for the extension of production are previously unemployed and find employment only with the appearance of the new savings.40

A correct view of the reactions on production as a whole of the investment of new savings must be envisaged in this way: At first the new savings will serve the purpose of transferring a portion of the original means of production previously employed in producing consumers’ goods to the production of new producers’ goods. The supply of consumers’ goods must, therefore, temporarily fall off as an immediate consequence of the investment of new savings (a circumstance constantly overlooked by Messrs. Foster and Catchings).41  No unfavorable effects on the sales of consumption goods follow from this, for the demand for consumption goods and the amount of original means of production employed in producing them decrease in similar proportions. And indeed even Messrs. Foster and Catchings do not make any such assertion. Their difficulties begin only at the moment when the increased volume of consumption goods, brought about by the new investment, comes on to the market.

Now this increase in the volume of consumption goods can only be effected through an increase in the volume of capital employed in production. Such capital, once it has been brought into existence, does not maintain itself automatically. This increase makes it necessary that, henceforward, a greater proportion of the existing means of production should be permanently devoted to the production of capital goods, and a smaller part to finishing consumption goods; and this shift in the immediate utilization of means of production must, under the conditions prevailing in the modern economic system, conform with a change in the relative amount of money expended in the various stages of production. But this question of the relation between the sums of money expended in any period on consumption goods on the one hand and on production goods on the other, brings us to the fundamental flaw in Messrs. Foster and Catchings’s theory.


  • “The ‘Paradox’ of Saving” is a translation of an essay that originally appeared in the Zeitschrift für Nationalökonomie, Bd. I, Heft III, 1929, under the title “Gibt es einen Widersinn des Sparens?” The translation is the work of Mr. Nicholas Kaldor and Dr. Georg Tugendhat and was first published in Economica, May, 1931. It is republished here with some minor textual revisions.
  • 2.W.T. Foster and W. Catchings: Money. Publications of the Pollak Foundation for Economic Research, No. 2, Boston and New York, Houghton Mifflin, 1923 (p. 277). (A third edition was published in 1928.)
  • 3.W.T. Foster and W. Catchings: Profits, Publications of the Pollak Foundation, No. 8, Boston and New York, Houghton Mifflin, 1925.
  • 4.W.T. Foster and W. Catchings: Business without a Buyer, Pollak Foundation, Boston and New York, Houghton Mifflin, 1927, second revised edition, No. 10, 1928.
  • 5.W. T. Foster and W. Catchings: The Dilemma of Thrift, reprinted from an article in the Atlantic Monthly under the title: “Progress and Plenty, a Way out of the Dilemma of Thrift”; together with another article published in Century Magazine. The pamphlet was published by the Pollak Foundation.
  • 6.Cf. Pollak Prize Essays, criticism of Profits, a book by W.T. Foster and W. Catchings, Pollak Foundation, 1927.
  • 7.Profits, p. 11.
  • 8.Op. cit., 268.
  • 9.Op. cit., p. 273.
  • 10.Dilemma of Thrift, p. 15.
  • 11.Profits, p. 281, where the following remark is appended to that qualification: “We here make that qualification, once and for all, with respect to every case in this and the following chapters,” which later gave the authors’ critics an opportunity to accuse them (Prize Essays, p. 12) of a misunderstanding of the main point of their argument.
  • 12.Profits, p. 284.
  • 13.Profits, p. 279.
  • 14.D.H. Robertson: “The Monetary Doctrines of Messrs. Foster and Catchings,” Quarterly Journal of Economics, Vol. XLIII, p. 483, May, 1929.
  • 15.P.W. Martin: The Flaw in the Price System, London, 1924; The Limited Market, London, 1926, and Unemployment and Purchasing Power, London, 1929.
  • 16.Profits, p. 294.
  • 17.Op. cit., p. 299.
  • 18.Op. cit., p. 302.
  • 19.Op. cit., pp. 302–13.
  • 20.Op. cit., p. 307.
  • 21.Profits, p. 324.
  • 22.Op. cit., pp. 330–1.
  • 23.Profits, p. 417.
  • 24.Op. cit., p. 416.
  • 25.Pollak Prize Essays: Criticisms of “Profits,” a book by W.T. Foster and W. Catchings. Essays by R.W. Souter, Frederick Law Olmsted, C.F. Bickerdike, Victor Valentinovitch Novogilov. Newton, Mass., 1927. Cf. also the introduction to Business without a Buyer.
  • 26.Op. cit., p. 6. See also the introduction to Business without a Buyer.
  • 27.To be mentioned especially are: A.B. Adams, Profits, Progress and Prosperity, New York, 1927 ; A.H. Hansen, Business Cycle Theory, its Development and Present Status, Boston, New York, 1927 (a prize essay published separately) ; H. Neisser, Theorie des wirt-schaftlichen Gleichgewichtes, Kölner sozialpolitische Vierteljahrschrift, Vol. VI., 1927, especially pp. 124–35; D.H. Robertson, “The Monetary Doctrines of Messrs. Foster and Catchings,” Quarterly Journal of Economics, Vol. XLIII, No. 3, May, 1929.
  • 28.Cf. Prize Essays, pp. 118–24.
  • 29.See below, p. 251.
  • 30.W.T. Foster and W. Catchings: The Road to Plenty (Publications of Pollak Foundation, No. n), Boston and New York, Houghton Mifflin, 1928; second edition, revised, 1928. A popular edition of 50,000 copies of the Road to Plenty was published and sold (230 pp., in full cloth binding) for 25 cents!
  • 31.W.T. Foster and W. Catchings: Progress and Plenty, A Way out of the Dilemma of Thrift reprinted from the Century Magazine, July, 1928. Reprinted also together with The Dilemma of Thrift. The second edition of The Road to Plenty, which I received after writing this article, takes over almost word for word the statements quoted here from Progress and Plenty.
  • 32.P. 16 of the independent reprint, p. 37 of the reprint together with The Dilemma of Thrift. Cf. also The Road to Plenty, 2nd Ed., p. 188.
  • 33.My italics.
  • 34.Progress and Plenty, p. 22 (42), and almost in the same words in The Road to Plenty, 2nd Ed., p. 193.
  • 35.The Road to Plenty, 2nd Ed., p. 209.
  • 36.Prize Essays, p. 5.
  • 37.Op. cit., p. 498.
  • 38.W.T. Foster and W. Catchings: Better Jobs and More of them. The Government’s Part in Preventing Unemployment. Reprinted from theCentury Magazine, July, 1929.
  • 39.Op. cit., p. 17.
  • 40.Messrs. Foster and Catchings seem to avail themselves of the assumption of an “industrial reserve army” — a notion much favored in trade cycle theory — from which the labor power necessary for a proportional extension of production can always be obtained at will. Quite apart from the incompatibility of this assumption with the known facts, it is theoretically inadmissible as a starting point for a theory that attempts, like Messrs. Foster and Catchings, to show the causes of crises, and thus of unemployment, on the basis of the modern “equilibrium theory” of price determination. Only on the basis of an economic theory that, like the Marxian, tries to explain the existence of permanent unemployment of considerable proportions independently of crises would such an assumption be theoretically permissible.
  • 41.Novogilov, who — as far as I can see — is the only critic who emphasizes this circumstance (p. 120, op. cit.), puts a favorable interpretation on the exposition in Profits, namely that the authors assume that “the population as a whole must increase its expenditure of labor, but consume not more than in the first years” (p. 108). But how should savings occasion an increased expenditure of labor?
Profile photo of F.A. Hayek

F.A. Hayek (1899–1992) was a founding board member of the Mises Institute. He shared the 1974 Nobel Prize in Economics with ideological rival Gunnar Myrdal "for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena."

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