Fishing at a Paradox. No Toil, No Thrift, No Fish, No Paradox.

Aggregation of economic variables is required for macroeconomic modeling.  One of the largest problems with macroeconomics is whether that aggregation makes sense, or conceals a more dynamic and diverse economy.

The paradox of thrift as proposed by Keynes assumes that all saving is similar.  People invest excess monies in some simple depositary instrument that earns interest.  As people panic over bad economic activity, they save more, driving interest rates lower.  But wait.  What if they don’t place their money in depositary instruments?  What if they pay down debt, whether secured or unsecured?  In that case, banks will find themselves more willing to lend, as the surplus/assets ratio rises.  The liquidity crunch at the banks will lessen.  Or, people may save in a different way, by:

  • Buying gold, commodities, or non-perishable consumables
  • Enhancing their homes, cars, etc., making them cheaper to operate, or giving them longer lifespans
  • Investing in foreign debt instruments

Saving can take many forms, some of which may look like consumption or investment.  The main idea is to direct your excess assets to the place that will give you the best long term benefit.

Even corporations will want to save during a tough environment.  Building up cash balances gives flexibility for the future, and gives options to buy assets cheaply if competitors crater.  Some firms even borrow long-term to have cash on hand.  It’s a negative arb, but it gives the firm flexibility.  But even firms may have alternative ways to save:

  • Investing in labor-saving or waste reducing technology.
  • Stockpiling needed nonperishable commodities, or locking in long-term supply agreements, at attractive prices.
  • Retiring stock or debt through buybacks at attractive prices.

Saving need not be in money markets or banks.  There are many ways to save, and there are always alternative uses for money.  Each economic actor has to find the most fitting savings method for his needs.

Now, recently I ran across a paper called The Paradox of Toil.  The abstract:

This paper proposes a new paradox: the paradox of toil. Suppose everyone wakes up one day and decides they want to work more. What happens to aggregate employment? This paper shows that, under certain conditions, aggregate employment falls; that is, there is less work in the aggregate because everyone wants to work more. The conditions for the paradox to apply are that the short-term nominal interest rate is zero and there are deflationary pressures and output contraction, much as during the Great Depression in the United States and, perhaps, the 2008 financial crisis in large parts of the world. The paradox of toil is tightly connected to the Keynesian idea of the paradox of thrift. Both are examples of a fallacy of composition.

This paper does the same simplifications that Keynes did to produce his paradox of thrift.  There is only one type of labor.  Well, certainly if everyone does the same thing, there are diminishing marginal returns to scale.  Big deal.

But labor is different.  We have the ability to choose different firms to work at.  Not all work is equal, and there are often better and worse opportunities available for labor.  Recessions occur partially because capital and labor are misallocated.  Look for the firms that are showing promise in the recession, and angle to work for them.

But beyond that, workers have one more option: work for yourself; start your own firm.  Find a problem that irritates many, and solve it.  Create a product or service that meets the needs of many.  In a deflationary environment that might mean finding a cheaper way to do things.  But it could be creating a new product that meets needs that people or businesses did not know they wanted.  Go for a Blue Ocean Strategy.

The best businesses are often created in recessions.  Flip the paradox of toil, and work many hours for yourself and your ideals.


I don’t believe in the paradox of thrift or the paradox of toil.  They are bogus results of oversimplified models that do not reflect reality.  As an investor and an economic historian, I know of many times where massive amounts of money were allocated to a single asset class or a single sector of the market.  If everyone follows a mania strategy, whether due to greed or panic, I can guarantee that there will be a bad result.

  • The dot-coms of the late ’90s
  • The one decision stocks of the ’60s.
  • Gold in the ’70s.
  • Railroads in the late 1800s.
  • Buying stocks in the 1920s.
  • Selling stocks in the 1930s.
  • Selling bonds in the early ’80s.
  • The mercantilist era — exporting cheaply to get gold, then getting less in return when liquidating the gold.

I could go on to various manias in earlier eras, less well-known manias, or individual stocks, but that wouldn’t help make my case any more than I have already.  The main point is the same.  Anytime everyone does the same thing, it is foolish.  It would be stupid for everyone to save using T-bills, or sell their excess labor to agricultural day labor.

I trust intelligent people to seek their best advantage in the markets.  That does not mean that foolish people will not get hosed.  That’s the nature of being foolish.  But bright people see recessions as a time to reorient and look ahead, to see what the new economy will want, and ignore what the old economy wanted.

So, I don’t see any value in:

  • Stimulus programs that don’t produce economic value.  If it only pays a wage, that is destructive.  For stimulus to be effective it must produce infrastructure that lowers the costs of the economy.  Think of all the useless projects built in Japan.
  • Paying extended unemployment benefits.  Additional consumption today, plus debt tomorrow is a recipe for economic lethargy.
  • Running large deficits.  If the money is not being spent on something that will produce future growth, it is a loss.
  • Bailouts of large financial institutions.  We have too many of those.
  • Housing tax credits.  We have too many houses.
  • Bailing out auto companies.  Too many autos are made in our world today.
  • Bailing out the GSEs.  They are deadweight losses.  Let them die, and let the senior bondholders feel the pain.  Let the junior bondholders be wiped out.
  • Monetary policy that steals from savers, thus depriving the private capital markets of a supply of private capital for productive investments, rather than the government absorbing most of the capital at low rates, and wasting the money on less productive projects.

Don’t listen to the fools that insist that we must run huge deficits and run a loose monetary policy.  A “big bang” would be preferable to the “Chinese water torture” that we are now undergoing.  Far better to take a short dose of sharp pain, where asset prices fall, some more banks fail, and bad debts are purged from the system, than to endure another lost decade, where the ability to employ capital productively is difficult.

As it is, we are pursuing the Japan solution to our overleverage.  They have had two lost decades, and are starting on their third lost decade.  Is that what we want?