Saving identity
The saving identity or the saving-investment identity is a concept in national income accounting stating that the amount saved in an economy will be the amount invested in new physical machinery, new inventories, and the like.
More specifically, in an open economy (an economy with foreign trade and capital flows), private saving plus governmental saving (the government budget surplus or the negative of the deficit) plus foreign investment domestically (capital inflows from abroad) must equal private physical investment.
This identity only holds true because investment here is defined as including inventory accumulation, both deliberate and unintended.
Thus, should consumers decide to save more and spend less, the fall in demand would lead to an increase in business inventories.
Indeed, businesses may respond to increased inventories by decreasing both output and intended investment.
Even if the end result of this process is ultimately a lower level of investment, it will nonetheless remain true at any given point in time that the saving-investment identity holds.
Investment as equal to savings is the basis of the investment-savings theory.
, the above equations are identities: they automatically hold by definition regardless of the values of any exogenous variables.
is redefined as only intended investment, then all of the above equations are no longer identities but rather are statements of equilibrium in the goods market.
In the general equilibrium model savings must equal investment for the economy to clear.
This increased productivity in laborers creates a surplus that will be split between capitalists’ expenditure on goods for themselves and investment in other capital.
Smith provides the example of the colonial United States for the positive relationship between the wage fund and investment in capital.
He says that England is a much more wealthy economy than anywhere in America; however, he believes that the true wealth lies within the market for wage funds and the growth rate of the population.
The colonies have a much higher wage rate than England due to a lower cost of provisions and necessities to survive, which result in a higher competition for human capital among the “masters” of the economy, which in turn raises the wage rate and increases the wage fund.
The core of this phenomenon is why Adam Smith believes in the saving-investment identity.
The reason why wages go up and there is competition between employers is the result of a constant influx of capital that is equal to or greater than the rate at which the amount of labor increases.
This rent adds no new value to society, but since land-owners are profit seeking, and since population is increasing in this time of growth, land that yields beyond the value of sustenance for workers is sought out and the return on those pieces of land suffers and lower rent.
The diminished rate of return results in something Ricardo calls the stationary state, which is when eventually a minimum profit rate is reached at which new investment (i.e., additional capital accumulation) ceases.
A larger population requires a greater food supply, so that, barring imports, cultivation must be extended to inferior lands (lower rent).
As this occurs, rents increase and profits fall, until ultimately the stationary state is reached.
