Savings and investment must be in balance

Press, 14 November 1977, Page 27

Savings and investment must be in balance

By

ADRIAN BROKKING,

commercial editor

If interest rates, and the prevailing interest climate, have such a substantial effect on the prices of securities, would it not be i useful to be able to predict 1 likely movements in the rates? The answer, of course, is yes; ability to foresee which way interest rates may be moving is very much part of the sharemarket game. The trouble is that to be able to do this an understanding is required of how interest rates are determined. And that in turn takes one fairly deep into economic theory. However, we shall have to tackle these questions — but we’ll take it nice and slowly, in something like three ■ articles. In the first article we shall look at the balance between savings and investment, in the second at the general conditions in which interest fates are set, and in a third at the forces determining those rates. As we have seen many times before, the object of investing is the increase of income. That income depends in the end on the investment’s ability to serve - a consumer’s need. This is so whether it is a car, a house, or a factory. A manufacturer does not build a factory for its own sake, but because he hopes

to use it to produce consumer goods to satisfy consumers’ wants, and so make a profit. If he does not produce consumer goods, he will produce intermediate goods which will be used by others to produce consumer goods. Always at the end of the production line looms a consumer and his wants. But the investment cannot come into being without an equal amount of saving. Because while a great number of people, from engineers to builders’ labourers, are building the factory, they are not producing the consumer goods on which they all want to spend their income. Everybody’s expenditure is part of someone else’s income. A small part of household expenditure may be spent on Wattle’s goods, which Wattie’s in turn pay out in rents, wages and salaries, interest charges, dividend payments, and for cost of materials to suppliers. These suppliers in turn spend their income on the various “factors of production.” It is obvious that most <4 the people who receive money from Wattie’s for their services, will spend some of it on Wattie products, just as the suppliers and their employees would As we widen this circle, ij

will be seen that our total expenditure is our total income: the national income. At the same time, all consumers are collectively the owners of the resources used in production: labour, land,, capital, and skills, ingenuity, and enterprise. It is a circular flow, or rather several circular flows, depending on which way we look. From consumers, who ire also resource owners, flows a stream of payments for goods and services to the nation’s productive and distribution units, and at the same time in the same direction a stream of productive services by the resources needed for production; from the production and distribution units, and again at the same time, flows a stream of income payments (rents, wages, interest, dividend, profit — their costs) to the consumers and resource owners, as well as a stream of goods and services. Therefore, national income — the sum of all incomes — equals national product “at factor cost’’ — the sum oi all the costs of producing the final products. This is a rough model, and it needs many refinements We have not taken intc account Government income and expenditure, exports anc imports, or transfer pay ments. However, these car all be quite easily in corporated into the model and we shall deal with then in the course of our inquiry. For the moment we are

more concerned with the impact of investment on the circular flow of goods. It wilt readily be seen that building the factory interrupts the circular flow: the income payments stream remains the same but the stream of goods and services is reduced: while the factory is being built you cannot produce consumption goods. To even out the flow the consumers and the makers of consumer goods must between them save enough of their income to pay for the building of the factory. Savings must equal investment, and the operative word is must. If the two are not equal, the economy gets into difficulties. For their services as resource owners consumers are paid in money which they may spend on consumption goods, or save, as they please. If, all together, they divide their incomes between spending and saving in the same proportion as the services (as resource owners) were divided between producing consumer goods and investment, everything will be fine. Because then the production of consumer goods will be equal to the demand for consumer goods. But in a free society there

is no law that says how much precisely each of us should save. If consumers want to spend too much on consumption, there will not be enough goods and services to meet the demand — unless prices are raised. In that case the producers of the goods will make extra profits which, if saved, may compensate for the lack of saving by consumers. But if these extra profits are not saved, they will add to demand and generate further price rises. You might say that the savings which were not initially made are being transferred to others. If, on the other hand, the nation saves too much, the producers of consumer goods will be left with larger stocks of goods than they anticipated when they made their production deci- . sions. They will be faced ( with lower” profits. This m.y s cause them to reduce their own consumption, which . would aggravate the prob- ’ lent, or they could reduce ■ their savings — which f would compensate for the , initial oversaving. Ideally, prices should be I reduced in order to clear the . larger stocks, but that ) seldom happens, and then > o n ly. locally and 1 spasmodically. Therefore, one of the funci tions of the rate of interest - is to keep savings and in- , vestment in balance. How i this works will be the topic of a future article.