Friday, 20 January 2012

Every man for himself

My eye was caught this morning by Polly Toynbee's assertion that "the paradox of thrift is just too paradoxical for the public."

I don't think people generally struggle with Keynes's insight once it is explained to them. (Of course, I'm talking about the "vulgar" explanation, rather than the more technical one concerning the relationship of savings and investment, zzzz...)

If we all cut back on spending and start paying off our debts at the same time, then there will be less spending overall. This will lead to cuts in production and lower sales, which will lead in turn to layoffs. This means even fewer people with money in their pocket to spend and more people fearful of further layoffs who try to build up their savings.

There, that was painless. Most people even get the rider that savings will increase despite near-zero interest rates and that surplus cash will be hoarded by businesses, leading to such phenomena as low gilt yields.

Toynbee's problem stems, I think, from the misconception that Keynes's formulation is a paradox (he never called it one - the term was applied later by others) and therefore puzzling.

From the perspective of the individual, it is perfectly rational to cut spending and pay down debt as this delivers a realisable benefit. The size of this benefit ultimately outweighs our guilt about the wider consequences - i.e. we are acting selfishly. We assuage that guilt (to a degree) by believing/hoping that not everyone else will be as selfish (or as smart) as we are.

In the extreme case (the classic interpretation of Adam Smith's "invisible hand"), the individual may even congratulate himself that he is morally in the right: "By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it." Now that is a paradox (if true).

I think most people understand the paradox of thrift. The problem is that we are more like Captain Schettino than Sidney Carton. It is this "unreliability" that underlies Keynes's further insight that when we, the private sector, take fright, government must step in to boost aggregate demand.

This brings us to the area of public understanding where it would be fair to say most people really are uninformed, namely the scale of personal and business debt relative to public debt. When we concentrate on our own debts, and the public discourse focuses on government debt, it is easy to see the former as tractable and the latter as intractable.

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