Lesson 2 of 8
Investment nobody chose
Resources diverted into longer processes without anyone deciding to consume less. The idea is older than the theory, and Hayek traced it to Bentham.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Forced saving is investment financed by resources taken from consumers who never agreed to consume less, through prices rather than through a decision.
- Hayek traced the doctrine back to Bentham, who called it forced frugality and treated the creation of paper money as a species of indirect taxation.
- The name is misleading in one way that matters. Nobody saved. What happened is a transfer, and it can be undone as soon as incomes catch up.
The previous course left a gap. If the longer processes were started with money nobody abstained to provide, what are the workers in those processes eating while they build.
Two ways the same investment gets financed
Voluntary saving
- Somebody chose to consume less.
- Goods were left unbought and are unclaimed.
- The person who gave something up gets the claim on future output.
- Nothing pushes the arrangement back.
Forced saving
- Nobody chose anything.
- Goods are bid away by borrowers spending new money.
- The people who gave something up get nothing for it.
- As incomes rise they restore their old spending, and the arrangement unwinds.
One is a decision. The other is a transfer effected by prices.
How the transfer actually happens
Not by anyone taking anything. Borrowers receive money that did not exist, they bid for labour and materials, and the prices of those things rise. Households whose money incomes have not yet risen find that the same income buys less.
Hayek's statement of it in the second lecture of Prices and Production is that the retrenchment is not voluntary, that it is not made by the people who will benefit from the new investment, and that it comes about not because people want to consume less but because they get fewer goods for their money income.
The idea is much older than the theory
Hayek wrote a short history of it, published in the Quarterly Journal of Economics in November 1932 and reprinted in Profits, Interest and Investment in 1939. His conclusion there is that the earliest and clearest statement is Bentham's, under the name forced frugality, in a passage that reached its final form in 1804 and appeared in the Manual of Political Economy published in Bowring's edition of the works in 1843.
Bentham's version has two parts. A government can raise the future stock of wealth by taxing present consumption, and it can produce the same effect by creating paper money, which he treats as a species of indirect taxation that had passed almost unnoticed. Hayek notes that Bentham, having described the power, immediately says it does not follow that it ought to be used.
Hayek also stresses that this was not a single discovery. The idea is mentioned repeatedly through the early nineteenth century in very similar terms, which is why he had to rewrite his own earlier sketch of its history.
Why the name is a bad name
Because no saving occurred. Saving is an act. What this describes is a redistribution of purchasing power, and the investment it finances is only as durable as the redistribution.
That is the sentence that matters for the rest of the course. The capital created this way exists, physically, in half-finished plant. Whether it goes on existing depends on whether the transfer continues, and the people it was taken from have every reason to end it.
Check yourself
What is forced saving?
- A legal requirement to save a share of income
- Investment financed by resources taken from consumers through rising prices, without anyone deciding to consume less
- Saving by firms rather than households
Show the answer
Answer: B.
Hayek's own statement is that the retrenchment is involuntary, is not made by those who benefit, and happens because money incomes buy fewer goods.To whom did Hayek trace the earliest clear statement of the doctrine?
- To Ricardo, in the Principles
- To Bentham, who called it forced frugality and treated created paper money as a species of indirect taxation
- To Wicksell, in 1898
Show the answer
Answer: B.
His 1932 note gives Bentham's passage, final form 1804 and published in 1843, as the earliest and most elaborate statement, while noting many similar nineteenth-century references.Why is the arrangement unstable?
- Because the banks will withdraw the loans
- Because nobody chose it, so the households it was taken from restore their old spending as their incomes catch up
- Because the plant physically deteriorates
Show the answer
Answer: B.
The capital exists, in half-finished form. Whether it keeps its value depends on whether the transfer continues, and the people bearing it have every reason to end it.Sources
- Hayek, 'A Note on the Development of the Doctrine of "Forced Saving"', Quarterly Journal of Economics, November 1932, reprinted as essay VII in Profits, Interest and Investment, 1939, for the attribution to Bentham's forced frugality, for the dating of that passage, for the treatment of created paper money as indirect taxation, for Bentham's own refusal to infer that the power ought to be used, and for the many similar early nineteenth-century statements.
- Hayek, Prices and Production, first published 1931, second revised edition 1935, lecture II, section 10, for the involuntary retrenchment of consumption, and for the point that it is borne by consumers in general rather than by the beneficiaries of the investment.
- Mises, The Theory of Money and Credit, German original 1912, English translation by Batson 1934, part three, chapter 5, section 4, for the requirement that a lengthening of production be paid for out of means of subsistence that exist.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The construction firm and its 200 workers are invented and describe no company.
- Bentham's own argument was about what governments may do and this lesson reports it as intellectual history. No position is taken here on monetary policy, taxation or the creation of money.
- Whether forced saving is quantitatively important in any actual episode is an empirical question this lesson does not answer, and the measurement problems are the subject of the last lesson of the previous course.