Time Preference and Net Consumption

Adapted from a Swedish blog post.

In case you are unfamiliar with these terms: “Time preference” refers to the fact that people (everything else equal) prefer a need satisfaction now or in the near future before the same need satisfaction in the more remote future. – “Net consumption” means the consumption of the capitalists, and the “net consumption theory” is the theory that the general level of profit in the economy is equal (or nearly equal) to the consumption of the capitalists. The theory is presented at length in George Reisman’s Capitalism: A Treatise on Economics, chapter 16.

Everything else equal, poor people have a higher time preference and – which is to say the same thing – a lower degree of future orientation than rich people. Take a homeless person, for example: he has to try to survive the day or the week; he is not in a position to set money aside for long-range projects or for his retirement. Another example would be a drug addict, whose time horizon is limited to his next “fix” – or an alcoholic who can only think of his next drink. – A less extreme example would be a poor farmer, who can only plan ahead for one year at a time; he needs this year’s harvest for him and his family to survive, and cannot put away more seed corn than is necessary for the next year’s harvest. (All farmers in Adam Smith’s “rude and early state” would be in this situation.)

At the other end of the spectrum, take a multi-billionaire such as Bill Gates or George Soros: he does not have to worry about surviving the next day, week, month, year or even decade; he can plan ahead for the future without having to concern himself too much with the present. He can even plan ahead for the time after his death and for securing the future of his children and grandchildren.

In between there are the rest of us: people with a moderate or fairly high income. We are in a position to set some of our money aside for the future: for buying a new house or a new car, providing for our children’s education, planning vacations, providing for our retirement.

But everything else is not always equal, so there are exceptions. A poor person may be struggling hard to get out of his poverty; and a very rich person may be squandering his wealth and end up poor.

If you are familiar with The Fountainhead, you may remember that Gail Wynand was sleeping on a couch in his office while building up The Banner and only later used his money to buy a yacht, create an art gallery, and commission a house from Howard Roark. – And for an example of rich people squandering their wealth, read Bernard de Mandeville’s The Fable of the Bees[1].

A change in the time preference of very poor people does little for the economy as a whole. Neither does such a change in the time preference of the few “squandering rich”. It is the time preference of the well-to-do and the industrious rich that makes a difference. As long as those people have a low time preference and a correspondingly high degree of future orientation, they will invest their money, and it is those investments that move the economy forwards.

According to George Reisman’s theory, the level of profit in the economy as a whole is equal to the net consumption of the capitalists (I leave net investment aside, because I don’t think it changes my point). As long as the capitalists have a low time preference, net consumption stays at this low level; the greater part of their wealth goes to productive investments. And the richer they become, the lower becomes their time preference, the more gets invested, the more gets produced, the more workers get employed and the higher their wages become.

But assume that the capitalists’ time preference would increase (and their future orientation would correspondingly diminish); this could happen if there were to be a serious threat of confiscation of their wealth by a socialist government (or if there were certain indications that doomsday was approaching and the world would come to an end). Then the opposite would happen: they would consume their wealth instead of investing it; production would diminish or cease altogether; unemployment would rise; and so would the general level of profit and interest.

And this is why time preference is not a direct but an indirect cause of the level of profit and interest. It works through the net consumption of the capitalists.

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Update December 26, 2015: As George Reisman has pointed out to me in a private message, it is not entirely true that capitalists will continue saving and investing indefinitely. As long as a capitalist is building his fortune, he will save and invest heavily out of his income and consume correspondingly less. But once his fortune is sufficiently large to make his own future – and even his children’s and his grandchildren’s – secure, he will have no incentive to further enlarge it, so he will save and invest less and less and finally may come to the point where he will consume all of his income. (For an extensive discussion of this, see Capitalism: A Treatise on Economics, pp.  739–744.)

I think (this is my own reflection) that this explains why so many of the greatest capitalists establish educational or other foundations (for example Rockefeller and Carnegie, and today Bill Gates and George Soros). From the point of view of the capitalist, this is consumption, since the purpose is not to make more money and enlarge his fortune, but simply to make the best use of the money he no longer needs.

George Reisman also tells me that

capitalists continue to save to the extent that the rate of profit/interest exceeds the rate of their consumption (the rate of net consumption). What causes this is the continuing increase in the quantity of money and volume of spending in the economic system. If the quantity of money and volume of spending ever stabilized at some given level, accumulated capital would grow to the point at which the consumption of the capitalists exhausted the whole of their incomes; at that point, saving out of  income would be zero.

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The honor of having discovered the role of time preference goes to Eugen von Böhm-Bawerk. Later “Austrian” economists, such as Mises, have considered his explanation of the causes of time preference as not quite satisfactory. But the one who nails it is, once again, George Reisman:

The nature of human life implies time preference, because life cannot be interrupted. To be alive two years from now, one must be alive one year from now. To be alive tomorrow, one must be alive today. Whatever value or importance one attaches to being alive in the future. one must attach to being alive in the present, because being alive in the present is the indispensable precondition to being alive in the future. The value of life in the present thus carries with it whatever value one attaches to life in the future, plus whatever value one attaches to life in the present for its own sake. In the nature of being alive, it is thus more important to be alive now than at any other, succeeding time, and more important to be alive in each moment of the nearer future than in each moment of the more remote future. If, for example, a person can project being alive for the next thirty years, say, then the value he attaches to being alive in the coming years carries with it whatever value he attaches to being alive in the following twenty-nine years, plus whatever value he attaches in the coming year for its own sake. This is necessarily a greater value than he attaches to being alive in the year starting next year. Similarly, the value he attaches to being alive from next year on is greater than the value he attaches to being alive starting two years from now, for it subsumes the latter value and represents that of an additional year besides.

The greater importance of life in the nearer future is what underlies the greater importance of goods in the nearer future and the perspective-like diminution in the value we attach to goods available in successively more remote periods of the future. (Capitalism: A Treatise on Economics, p. 56.)

To put it in shorter words: To be alive today and this year is the necessary pre-condition of being alive tomorrow or in fifty or a hundred years. Everything else equal, we have to value life in the present over life in the future, for if we don’t, there will be no life in the future. Thus we have to have goods or money to survive the day before we can start thinking about saving for the future.

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I originally wrote this some years ago, when I was pulled into a discussion with an idiot not too well-informed person, who claimed that George Reisman could not be a real “Austrian”, since he does not share the conventional “Austrian” view om time preference.

(Other schools than the “Austrian” have no inkling of the role of time preference.)

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See also my earlier blog post Christianity and Time Preference.


[1]) Mandeville claimed that this squandering would be a boon to the economy; but this is simply a version of the “broken windows” fallacy and has been refuted time and again by better economists.

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Christianity and Time Preference

Adaptation of a Swedish blog post.

If you are acquainted with “Austrian” economics, you know what is meant by “time preference”: it refers to the fact that, everything else equal, a need satisfaction today is more important and higher valued than the same need satisfaction  at some time in the future. You also know that time preference is the ultimate determinant of the level of profit and interest in the economy, of what is commonly called “originary interest”.[1]

Is time preference a good thing or a bad thing? Well, if we had no time preference at all, we would not consume anything in the present and save and invest everything we have. But this, of course, is not possible: if we consume nothing in the present, we would quickly starve to death, and then, what point would there be to saving and investing? (I know this is a drastic example.) But neither would it be a good thing if our time preference were infinite and we were to consume everything today with no provision at all for the future. So we weigh the past against the future and decide how much we can consume today against saving and investing for the future.

A poor man tends to have a higher time preference than a rich man. For example, a homeless person is not in a position to plan very far ahead; he lives “from hand to mouth”. A multimillionaire, on the other hand, does not have to worry at all about how to get his next meal or finding shelter for the night, and is in a position to plan how to best invest his millions. And the rest of us are somewhere in between those extremes.

On the other hand, even a poor man can have relatively low time preference – if he is struggling to rise above poverty. (Many millionaires have started their lives as relatively poor.) And the other extreme would be the worthless heir who is squandering his wealth.

Time preference also varies with age. A baby or a toddler has high time preference, simply because he is not yet aware of such a thing as a “future”. But it is rather early in life that a child starts to think about what he wants to become when he is grown up. And old people may have high time preference, because they do not have much of a future to plan for; but this is mitigated if one has heirs and cares for their future.

But what has Christianity to say about time preference? Let me quote the Sermon on the Mount:

Therefore I tell you, do not worry about your life, what you will eat or drink; or about your body, what you will wear. Is not life more than food, and the body more than clothes?  Look at the birds of the air; they do not sow or reap or store away in barns, and yet your heavenly Father feeds them. Are you not much more valuable than they?  Can any one of you by worrying add a single hour to your life?

And why do you worry about clothes? See how the flowers of the field grow. They do not labor or spin.  Yet I tell you that not even Solomon in all his splendor was dressed like one of these.  If that is how God clothes the grass of the field, which is here today and tomorrow is thrown into the fire, will he not much more clothe you—you of little faith?  So do not worry, saying, ‘What shall we eat?’ or ‘What shall we drink?’ or ‘What shall we wear?’  For the pagans run after all these things, and your heavenly Father knows that you need them.  But seek first his kingdom and his righteousness, and all these things will be given to you as well.  Therefore do not worry about tomorrow, for tomorrow will worry about itself. Each day has enough trouble of its own. (Matthew 6:25–34.)

In short: Why care about the future? God will take care of you! Well, is God really taking care of the homeless? No. The homeless are able to survive, because they live in a world where even the poorest enjoy some standard of living – a standard of living provided by capitalists and business men, i.e. by people with a very low time preference. (For more on this, see George Reisman’s article In Praise of the Capitalist 1 Percent, also available on Reisman’s blog.)

Now, I do not think many Christians actually live by Jesus’ recommendation here – if they did, they would all be homeless and beggars, and if they live in a world of Christians following Jesus’ advice, from whom would they beg? – Nevertheless, this is what he preaches.

Is this idea compatible with capitalism or with civilization? The question is rhetorical.


[1]) See on this Eugen von Böhm-Bawerk, Capital and Interest, Vol. II, Book IV; Ludwig von Mises, Human Action, chapter XVIII. – On exactly how time preference determines the profit and interest rate, see George Reisman, Capitalism: A Treatise on Economics, especially p. 492ff.

Horror Quote from Joseph Schumpeter

Joseph A. Schumpeter was one of Eugen von Böhm-Bawerk’s star pupils; another one was Ludwig von Mises. A couple of years ago I wrote a piece called Stray Observations on Joseph A. Schumpeter, where I tried to sort the wheat from the chaff in his book Capitalism, Socialism and Democracy. I also read his The Great Economists (in a Swedish translation), a series of monographs on some economists, from Marx to Keynes. One thing that struck me was that he lavishes as much praise on Marx and Keynes as he does on Menger and Böhm-Bawerk. This should be enough to establish that I regard Schumpeter as a “mixed bag”.

But there is some real poison in the mixture. From a Mises.org article by Gary North[1]:

Felix Somary records in his autobiography a discussion he had with the economist Joseph Schumpeter and the sociologist Max Weber in 1918. Schumpeter was an Austrian economist who was not an Austrian School economist. He later wrote the most influential monograph on the history of economic thought. Weber was the most prestigious academic social scientist in the world until he died in 1920.

Schumpeter expressed happiness regarding the Russian Revolution. The USSR would be a test case for socialism. Weber warned that this would cause untold misery. Schumpeter replied, “That may well be, but it would be a good laboratory.” Weber responded, “A laboratory heaped with human corpses!” Schumpeter retorted, “Every anatomy classroom is the same thing.” [Felix Somary, The Raven of Zurich (New York: St. Martin’s, 1986), p. 121.]

Schumpeter was a moral monster. Let us not mince words. He was a highly sophisticated man, but he was at bottom a moral monster. Anyone who could dismiss the deaths of millions like this is a moral monster. Weber stormed out of the room. I don’t blame him.

I don’t blame him either.


[1]) Gary North is a new acquaintance to me, but Wikipedia informs that he tries to combine “Austrian” economics with Christian beliefs.