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check out my vertical integration. and my beard. and my gun.

Noah Smith mused about a subject I’m interested in – the fundamental conceptual issues at the nature of saving – in a way I like to muse about it – thought experiments – so how could I not deconstruct his post in excruciating detail?

Specifically, I’d like to focus on the economy of his deer hunter (one of many, in his example, but just one for this purpose): a man who lives, alone, in the woods, hunting deer. I’m going to break this down as much as I can while abstracting away the non-deer parts of his economy (shelter, clothing, tools, etc). Because the deer hunter is an economy – and while he might be an economy of only one human, who we’ll call Vronsky -, we can productively and fruitfully view him as a vertically-integrated economy, and break him down into four sectors:

1) A firm that hunts deer. The firm locates as many deer as possible and kills them, then sells them to the next sector. It has most fixed costs (labor to hunt deer) and therefore pays relatively fixed wages, the rest collected as profit.

2) A firm that processes dead deer into venison. This firm always purchases all the deer killed by the first firm, and always sells all of its venison to the next two sectors. It has more variable wages (because it has variable labor as its primary input) and takes the rest as profit.

3) A firm that stores processed deer. This firm always buys all the surplus venison produced by the processing firm, salts it, and stores it until there is a market for it. We will discuss its economy in more detail below.

4) The consumer. It always buys a certain amount of venison (let’s call it C) no matter what.

Now, in actuality, all these firms are the same person – Vronsky, who owns all the firms, provides all the labor, and collects all the wages and profits (which he then proceeds to, largely, eat). But we can break the internal economy of his life away from Williamson-ian integration and imagine a market that works something like this:

There are flush years and lean years – periods, that is, in which D (the amount of deer caught by the hunting firm) is either greater than or less than C. Let’s see what happens in a flush year.

The first firm kills some amount of deer, D, that is bigger than C (we’ll call it C + S). It sells C + S deer to the second firm, pays its wages, and collects profit (let’s imagine the firm breaks even in years when D = C).

The second firm processes all the deer into venison, and sells C venison to the consumer and S to the third firm. This firm always breaks even because its labor varies in direct proportion to its production which varies in direct proportion to the available venison.

Now, the third firm. What should be clear is that the third firm is the closest this economy has to a financial sector – it buys venison when it’s plentiful and sells it when it’s, er, dear. This means it, essentially, stabilizes the internal price of venison (and also raw deer). It also is a very different firm from the other two, since labor is a minimal input – it is a capital-intensive firm that specializes in storage and market mastery (we’re assuming it inherits all the capital, physical and intellectual). Assuming our flush year is t=1, the firm has costs – purchasing the venison, salting it, and storing it – but no revenue. Which means it has to borrow. From whom? The consumer’s wages should always = C, so it must borrow from the profitable sector of the economy – the first firm, who has profited from a plenty of deer to kill. Essentially, the amount of raw deer necessary to produce an amount of venison = C costs exactly the wages of a year’s worth of deer hunting, and the wages of processing the deer into venison are equal to the mark-up of venison over deer, meaning all the profits flow to the first firm – the hunting firm. So it loans the money to the third firm, the storage firm.

This works in reverse in lean years. In a lean year (let’s say t=2 is exactly as lean as t=1 is flush, so C-S) the hunting firm is in the red, since it pays wages beyond it’s revenue. However, it can call in a loan from the storage firm, which has almost no costs incurred but suddenly tons of revenue from selling its surplus! So it can pay back the loan to the first firm. So there are now no net savings, nominally or physically. Balance. Om.

But let’s say there isn’t long-term balance. That creates two potential scenarios – one of long-term scarcity, whose end is obvious and really quite sad for poor Vronsky. But long-term plenty is more…interesting.

If there is long-term plenty, a couple things could happen. If we are speaking strictly ceteris paribus, then we would see larger and larger imbalances between the accumulated bonds of the hunting firm and the accumulated debt of the storage firm, ending in…financial crisis! Salted venison doesn’t last forever, so it would be essentially squatting on toxic assets it would be loathe to revalue without the projected revenue to pay off it’s accumulated debt. It would go belly-up, and basically need its loans forgiven – by which we mean, of course, that Vronsky has to write off a lot of old, stinky venison into the river.

But assuming non-ceteris paribusitywhat we would actually see is that, as salted venison becomes plenty, prices decline to the point where no amount of hunting can support the wages of the hunting firm. To skip the boring stuff, what happens is that Vronsky consumes more leisure as he eats down his stock of salted venison and takes up whittling or something.

Now, over the truly long term, endless plenty absent productivity increases is impossible for Malthusian reasons unless you want to assume a Children of Men kind of deal. But even there, we wouldn’t see infinite saving because Vronsky would, sitting on a giant pile of meat, only hunt to the extent he wanted to, not needed to.

The key, in the end, is this – that saving is just as much about production than consumption, and it’s really about the future-orientation of production. In a world where Vronsky is alone, and has no reason to invest in future growth, he won’t endlessly stockpile venison because of diminishing returns and will therefore shift to other forms of spending his time. But in a world where Vronsky was future-oriented, at least minimally, he might spend his savings to create extra time he could use to develop more efficient hunting tools, thus saving even more time in the future. Or he could develop a game that would amuse him. Or he could pack a sack full of salt venison and go on a quest to find a friend, or at least a basset hound.

The real point, in the end, is that nominal savings (which always equal nominal debt) are very disconnected from whether current production is creating value for the future. In the 00’s we simply invested too much of our productive capacity in building overly-large houses in low-cost but low-value locations, which created a lot of nominal debt and therefore nominal savings but didn’t enable the United States to be more productive in the future. On the other hand, higher taxes that built high-speed rail wouldn’t show up as saving, but from the perspective of society, we would be deferring fleetingly pleasurable consumption of movies and candy and craft beer and what have you towards building valuable infrastructure that would make us richer in the future. That’s not nominal savings, and in the short-term GDP looks the same, but that’s true saving in the modern world.

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I have invented an amazing device! It is a tremendous healing ray that instantly and costlessly cures all chronic ailments! Huzzah! A great boon for humanity!

"But wait!" says the inner economist. "What happens to labor markets?"

Sigh. Good question.

First, assume the demand for health services is unchanged (for whatever reason, just assume it, damn it, this is economics. The health sector is it’s own damn mess).

Now – what happens?

Presumably most persons suffering from some kind of ailment or disability recieve a zapping. Obviously there are communities of interest and affiliation surrounding certain kinds of disability and for many people there are questions of identity involved, but even though we don’t presume a 100% participation rate in "being bathed in the healing light of my white magic phaser" it would probably be something close.

I think, first and foremost, that we can agree that those who have been so blasted with blessing would both be more productive and experience higher wages. They would be capable of doing certain kinds of work they were previously incapable of, capable of doing their existing work better, and capable of returning to the workforce if they had been so substantially disabled that they could no longer work.

Secondly, Social Security Disability would go from spending $183 billion annually (including Medicare payments for beneficiaries) to paying something a lot closer to $0. Some of that would now be offset by things like the EITC, Medicaid and exchange subsidies (let’s assume this happens next year because why not keep assuming?), and unemployment benefits (temporarily expanded to help smooth the income of the suddenly rapidly expanded workforce), but overall this probably is a net boon to the state’s coffers.

Here is a key question – what happens to existing workers? Clearly, overall potential productivity in the economy has gone way up – many more individuals are capable of producing more, and nobody has suffered any absolute degredation in ability or capacity. But still, many workers would be close substitues to the sudden army of the newly-able, all across the board, from the previously-parapalegic who are now would-be waiters and construction workers to the previously blind and deaf who are now would-be lawyers and consultants. So…what happens?

Well…it depends, doesn’t it? There’s no good reason we would expect a substantial increase in per-capita productive capacity to result in tremendous unemplyoment, is there? We might expect some short term…well, let’s not call it chaos, but perhaps friction? But within a year or so, given the correct response from governing institutions (especially monetary institutions) we would expect aggregate demand would "catch up" with potential aggregate supply and find an equilibrium at a higher absolute level of production and employment. This all assumes, of course, that a USA whose absolute net labor force increased sharply and substantially wouldn’t hit some global supply constraint, like, say, a finite amount of flamable black goo that was for some reason very important. But let’s assume that too! Because, as my mother always told me, assuming makes a mensch out of you and me! That’s totally what she said.

Anyway, the short version is, assuming proper response from key institutions and a lack of economy-wide medium-term supply constraints, there is no reason to think that waving a magic wand that increased the potential productivity of the labor force would inevitably induce net harm on any specific group. This could be, not just a weak Pareto improvement, but a strong one.

Now, what if the disability wasn’t physical, but legal? What if it were, say, some sort of legal status somewhat-arbitrarily assigned to a large group of workers that rendered them less productive then they could be otherwise? And then we waved our magic wand of law and removed that restriction? Who would that hurt?

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