Or, the labour theory of value and the tendency of the rate of profit to fall.
As individuals, we save expecting to be able to spend our savings on commodities in the future. But the commodities sold in any time period are generally produced within that period. Savings represent income from the production of commodities that are not spent on those commodities. Spending out of previous savings represents spending on commodities that does not come from income generated in producing them. Is there some mechanism channelling savings into expanding future production such that future production is capable of meeting the demand when savings are spent?
It’s tempting to simply assume that savings flows into just the right investment to prepare for future demand: as we have seen, savings and investment are equal by definition. Some of the classicals saw the interest rate as adjusting savings an investment in just the right proportion to match the future consumption made possible by saving/investing now with the sacrifice in consumption now.
But saving sends no signal about what the saver wants to purchase down the track, or when they will make the purchase. And investment is based upon expectations of future consumption, but those expectations are “so largely based on current experience of present consumption”, and present consumption is reduced by an act of saving. [p. 210] Saving makes prospects for investment look bleaker than they otherwise would. So saving may reduce current investment-demand as well as consumption-demand.
The absurd, though almost universal, idea that an act of individual saving is just as good for effective demand as an act of individual consumption, has been fostered by the fallacy, much more specious than the conclusion derived from it, that an increased desire to hold wealth, being much the same thing as an increased desire to hold investments, must, by increasing the demand for investments, provide a stimulus to their production; so that current investment is promoted by individual saving to the same extent as present consumption is diminished. [p. 211]
An individual act of saving transfers claims over wealth to the saver; it does not necessarily create new real wealth (i.e., investment in capital goods). It might bid up the price of financial assets (which would lower the interest rate and possibly induce investment). Or it might increase the demand for money (which would raise the interest rate and discourage investment).
Is capital productive?
Keynes’ answer is no. Capital has a yield over its existence in excess of its cost, but this should not be confused with physical productivity. If capital becomes less scarce, its yield falls, even though it may be just as physically productive as it was before. Again, we have a more-than-casual nod to a labour theory of value:
I sympathise, therefore, with the pre-classical doctrine that everything is produced by labour, aided by what used to be called art and is now called technique, by natural resources which are free or cost a rent according to their scarcity or abundance, and by the results of past labour, embodied in assets, which also command a price according to their scarcity or abundance. It is preferable to regard labour, including, of course, the personal services of the entrepreneur and his assistants, as the sole factor of production, operating in a given environment of technique, natural resources, capital equipment and effective demand. This partly explains why we have been able to take the unit of labour as the sole physical unit which we require in our economic system, apart from units of money and of time. [pp. 213-14]
Keynes follows with a swipe at Böhm-Bawerk (author of Karl Marx and the Close of His System) and his argument that capital could be represented as a ’roundabout process’. He shows that for various reasons the representation of capital as time is incoherent.
Of course it is not Keynes’ argument (or Marx’s or any of the classicals’) that capital does not make production processes more efficient. He simply argues that this does not explain the return to capital, which is determined essentially by its scarcity. And capital is not alone here:
Moreover there are all sorts of reasons why various kinds of services and facilities are scarce and therefore expensive relatively to the quantity of labour involved. For example, smelly processes command a higher reward, because people will not undertake them otherwise. So do risky processes. But we do not devise a productivity theory of smelly or risky processes as such. [p. 215]
The fact that the marginal efficiency of capital depends on its scarcity suggests a problem: what happens to a capitalist society where capital is no longer scarce, so that its marginal efficiency falls to zero? People will still be inclined to save, but any addition to the capital stock will be worth less than nothing.
Starting from full employment, the excess of saving over investment will lower income until the aggregate rate of saving is zero, in line with investment.
Thus for a society such as we have supposed, the position of equilibrium, under conditions of laissez-faire, will be one in which employment is low enough and the standard of life sufficiently miserable to bring savings to zero. More probably there will be a cyclical movement round this equilibrium position. For if there is still room for uncertainty about the future, the marginal efficiency of capital will occasionally rise above zero leading to a “boom”, and in the succeeding “slump” the stock of capital may fall for a time below the level which will yield a marginal efficiency of zero in the long run.
Of course, the marginal efficiency of capital need not fall all the way to zero to choke off investment – it only needs to fall below the minimum interest rate. Keynes argues that the rate of interest (on long-term bonds) cannot fall below some minimum set by uncertainty and the cost of bringing lenders and borrowers together – around 2 or 2.5 per cent in present conditions. Therefore, there is every possibility that in wealthy countries “the awkward possibilities of an increasing stock of wealth, in conditions where the rate of interest can fall no further under laissez-faire, may soon be realised in actual experience.”
In fact, Keynes conjectures that these conditions already apply in the United States and Great Britain. Poorer countries (i.e. with a relatively lower capital stock) may thus enjoy a higher standard of life than richer, if the latter suffer declines in employment due to a lack of an incentive to invest; “though when the poorer community has caught up the rich — as, presumably, it eventually will — then both alike will suffer the fate of Midas.”
So Keynes follows an argument that only labour can be considered productive with a law of the tendency of the rate of profit (sorry, “marginal efficiency of capital”) to fall. Very interesting!
The way out, according to Keynes, is for savings to be matched by expenditure on durable assets that are not expected to make a return (i.e., they are not capital goods).
In so far as millionaires find their satisfaction in building mighty mansions to contain their bodies when alive and pyramids to shelter them after death, or, repenting of their sins, erect cathedrals and endow monasteries or foreign missions, the day when abundance of capital will interfere with abundance of output may be postponed.
It would be better if “a sensible community” realised the causes of the situation and dealt with it rationally, via state expenditure on non-capital assets. Such a community would be fast on the road to Keynes’ version of utopia:
On such assumptions I should guess that a properly run community equipped with modern technical resources, of which the population is not increasing rapidly, ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation; so that we should attain the conditions of a quasi-stationary community where change and progress would result only from changes in technique, taste, population and institutions, with the products of capital selling at a price proportioned to the labour, etc., embodied in them on just the same principles as govern the prices of consumption-goods into which capital-charges enter in an insignificant degree.
If I am right in supposing it to be comparatively easy to make capital-goods so abundant that the marginal efficiency of capital is zero, this may be the most sensible way of gradually getting rid of many of the objectionable features of capitalism. For a little reflection will show what enormous social changes would result from a gradual disappearance of a rate of return on accumulated wealth. A man would still be free to accumulate his earned income with a view to spending it at a later date. But his accumulation would not grow. He would simply be in the position of Pope’s father, who, when he retired from business, carried a chest of guineas with him to his villa at Twickenham and met his household expenses from it as required.