Paradox of Thrift

30.08.2018 |

Episode #4 of the course Brain-twisting paradoxes by John Robin


Welcome back!

Today we will explore another brain-twister: how you can actually save more money by spending it. Forget savings! This paradox reveals how being frugal isn’t as beneficial as we think.


A New Savings Strategy

If you’re broke, your instinct is probably to spend less, i.e., save money. If you make lots of money, by the same reasoning, it makes sense to save money for those times you’re broke. This is common sense so far.

Now, let’s take a look at this from another angle.

Assume you’re broke, and you still have to pay your bills. Let’s imagine you have a personal trainer and this costs you $200/month. You’re paying for edits on an upcoming novel. You have a car and have to pay car fees; you live on the outskirts of town, so if you get rid of your car, you’ll be housebound. You also have a wellness coach and this helps you stay focused.

It all costs a lot of money! And you’re broke!

But here’s the thing: You have to pay your bills.

This forces you to work harder, and driven to have to pay your higher costs, you open yourself up to more opportunities. You take on side jobs and explore other income channels. You might struggle and barely make it, but the point is, having the pressure of having to pay those costs, you work harder and become more resourceful.

Now, let’s imagine this scenario, with the opposite approach:

You cut all costs out of your life. You don’t have to spend anything extra, and therefore, you don’t have to work more and become more resourceful. You sell your car and don’t leave your house. You have reduced the demand in your life, and your required employment/income generation (supply) goes down. Being frugal actually makes you make less resourceful because your demand to work is less and you won’t work as hard as you would have if you were pressed to make the extra money.


The Paradox of Thrift

This is a personal imagining of what’s known in economics as the paradox of thrift. Imagine that instead of you, you are imagining an entire economy, i.e., the collective whole of the United States.

If the country has lots of costs—i.e., demand of its citizens for resources is high—then the country must, in turn, find ways to make its citizens more productive (higher employment rates); this brings in money through taxes and exports. Supply (what the citizens in the country can create through work) goes up.

Now, when a country cuts spending on the improvement of its citizens, those citizens don’t have as many opportunities. Supply of labor decreases and the country makes less. This is analogous to what happens to you when you cut out every single expense so you can match your income.

The paradox of thrift is attributed to economist John Maynard Keynes. The paradox itself focuses more on the idea that individual savings aren’t necessarily better for the whole. This is, in fact, similar to the prisoner’s dilemma we covered on Day 2: According to this paradox, sacrificing for the good of the whole is better for the whole. Individuals who save for tough times are wasting economic resources that could be invested in the economy so other citizens can work and the country as a whole can improve far more than the individual savings.

The takeaway from today’s lesson is not that you should start spending lots of money so you have to get extra credit cards, but rather that if you have key expenses that yield important results, then as risky as it may seem, you are better off to push yourself to your limits to find ways to afford those, so you can not only continue to produce results but also innovate and produce even more than you would have otherwise.

And thinking about this from a larger perspective, by spending rather than saving, that money is going into the collective economy and making work for others, so you’re all producing together. The lesson is not just to spend, but to spend wisely, with the larger economic whole of your money flow in mind.

Speaking of considering the larger picture, get excited for tomorrow, when we’ll be moving on to a paradox about omnipotence!


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Recommended book

The General Theory of Employment, Interest and Money by John Maynard Keynes


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