Frank Shostak

According to some commentators such as economics Nobel Laureate Paul Romer, technical knowledge is key to economic growth. But if this is the case, why do third world economies continue to experience poverty? After all, individuals in these economies have access to the same technical knowledge as the developed world.

Careful examination, however, shows that a key driver of economic growth is the pool of consumer goods, or the subsistence fund.

Consumer Goods and Economic Growth

To maintain life and well-being, man must have at his disposal an adequate amount of final consumer goods. These goods, however, are not readily available—they have to be extracted from nature. Without tools at his disposal, man can only secure from nature minimum goods for his survival. This principle can be illustrated with a simple example.

For instance, take an individual, John, stranded in a forest. In order to stay alive, he must pick some apples from an apple tree. Apples are the only good available to him that can sustain him. Let us say that by working twenty hours a day John manages to secure twenty apples, which keep him alive. The twenty apples that John has secured from nature are his subsistence fund, which sustains him.

Being a sophisticated individual, John realizes that if he had a special stick he would become more productive. His daily production of apples could be forty (i.e., double his current production).

The problem, however, is that the stick is not available—it must be made. Two days of work are required to make the stick. If John were to decide to make the stick, he would have a problem. If he spent his time making the stick, he would not be able to pick the apples that he requires to stay alive.

The way out of this dilemma is for John to put aside an apple a day for the next forty days. By saving an apple out of his daily production and enduring hunger, after forty days he will have an adequate stock of apples that will sustain him while he is busy making the special stick. (We make the unrealistic assumption here that apples can be preserved in edible form for forty days to illustrate the importance of saving.)

Thus, after forty days, John’s subsistence fund will comprise forty apples, which will see him through while he is making the special stick. We can see here that the saved or unconsumed forty apples enable the making of the stick, which raises the future production of apples and lifts John’s living standard.

Let us slightly alter the previous example and introduce another individual, Rob, who specializes in making the special sticks. Because he is an expert in stick making, it takes him only one day to make the special stick that John requires. Rob also has to have twenty apples a day to keep him going. Now rather than saving forty apples, John needs to save only twenty, which will enable him to hire the services of Rob.

Observe that John’s saved twenty apples sustain Rob the stick maker, while John is maintained by his current daily production of apples, which is also twenty apples.

Note that the making of the stick is a burden—John has to make a sacrifice and save twenty apples, thereby endangering his health and well-being. However, after twenty days he will be able to use the stick, which will allow him to double his production of apples. If he continues to consume twenty apples a day, this will allow John to increase his subsistence fund.

Thus, on the first day, John’s subsistence fund will be forty apples, of which twenty are allocated for immediate consumption and twenty are saved. On the second day, his fund will consist of twenty saved apples plus forty more apples from current production—i.e., he now has sixty apples in his fund, of which twenty are consumed and forty saved. On the third day, his fund will have eighty apples in it (i.e., forty apples from his daily production and forty from savings). Out of this John will consume twenty apples and save sixty, etc. As the subsistence fund expands, John can hire the services of other individuals who can maintain and enhance his production structure, and can thereby raise further his production of apples.

The Subsistence Fund

The state of the subsistence fund determines the quality and the quantity of various tools that can be made. If the fund is only sufficient to support one day of work, then the making of a tool that requires two days of work cannot be undertaken.

The size of the fund sets the limit on the projects that can be implemented. It also means that the size of the fund determines economic growth. (As the fund increases, it permits a greater production of apples.)

On this, Richard von Strigl wrote:

Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides labourers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs for a period of one year…. The greater this fund, the longer is the roundabout factor of production that can be undertaken, and the greater the output will be. It is clear that under these conditions the “correct” length of the roundabout method of production is determined by the size of the subsistence fund or the period of time for which this fund suffices.1

The essence of the subsistence fund with respect to the individual John can be widened to include many individuals who trade with each other. John, who produces apples, can now secure meat and clothing from other individuals. This means that the subsistence fund now comprises a greater variety of final goods ready for human consumption. According to Eugen von Böhm-Bawerk:

The entire wealth of the economical community serves as a subsistence fund, or advances fund, and, from this, society draws its subsistence during the period of production customary in the community.2

Note again that the improvement in the infrastructure is what sets in motion economic growth. The improvement in the infrastructure in turn can take place because of the increase in the subsistence fund. Hence, anything that weakens the subsistence fund undermines the prospects for economic growth. Again, individuals who are engaged in the various stages of production require access to final consumer goods, i.e., a subsistence fund, in order to live.

Observe again that the part of the pool of consumer goods allocated toward the expansion and maintenance of the infrastructure is also considered real savings. The improved infrastructure permits not only the increase in consumer goods but also the introduction of various services that were not available before.

Without the Pool of Consumer Goods, New Ideas Can’t Generate Economic Growth

In light of this we can see that new ideas can do very little for real economic growth without an expanding pool of consumer goods.

In Man, Economy, and State, Murray Rothbard says that technology, while important, must always work through the investment of capital in order to generate economic growth. On this issue Rothbard references Mises, who says that

What is lacking in these [underdeveloped] countries is not knowledge of Western technological methods (“know how”); that is learned easily enough. The service of imparting knowledge, in person or in book form, can be paid for readily. What is lacking is the supply of saved capital needed to put the advanced methods into effect.3

So regardless of how knowledgeable we are and regardless of various technological ideas, without an expanding pool of real savings, economic growth is not going to emerge.

It is through the expansion in the pool of real savings that an increase in the stock of capital goods is possible. The increase in capital goods permits the increase in economic growth to emerge.

For instance, to make a particular tool the tool maker must have an idea of how to make this tool. The idea alone, however, will not be sufficient to produce the tool. Various elements to make the tool must be produced before it can be assembled.

In the various stages of production, i.e., intermediate and final stages, the individuals who are employed in these stages must be supported by final consumer goods, which sustain them.

Without the allocation of consumer goods, i.e., real savings, toward the individuals employed in the various stages of production, productivity-enhancing tools cannot be made, notwithstanding the technical knowledge of how to make them.

Source; Mises Institute