What is time preference? What is high and low time preference? Why save and invest? What are the conditions necessary for the investment to be possible? How can you build a civilization?

▪ What is time preference?

Mark took a job offer to paint a house. His employer offered him $1000 for his work. When Mark painted the house, he went to his employer and asked for the money. “Of course, Mark”, he replied, “I will give you the money in 2 years. I never said I would give it to you immediately.”

We can expect that Mark would not be very happy with the employer’s reply. Even if he was absolutely sure that he will get the money in 2 years, and that the money would be worth the same, Mark would rather have it now, not later.

People are not indifferent as to when their needs are satisfied. They would rather satisfy them sooner than later. As Ludwig von Mises writes: “There is no man for whom the difference between sooner and later does not count”.1 The phenomenon that people prefer to achieve the same satisfaction sooner rather than later is called time preference. Time preference is always positive – people always want to achieve the same satisfaction sooner rather than later. What would happen if the time preference was negative? One would postpone his consumption indefinitely. This situation is impossible, because people need to consume to live. With negative time preference, people would only accumulate goods, and never consume them.2 This shows us, that time preference must be positive.

The fact that a human being is limited by time preference, influences his production choices. Let’s use the example presented by Hans Herman Hoppe. Let’s imagine Robinson Crusoe on the desert island. He has to get food, so he decides to fish. If the only thing he would have to consider was the amount of fish he can get, no matter how much time it would take, he would start building a big fishing boat right away. It would take years, but surely the fishing trawler would be a much more effective fishing tool than his bare hands, fishing net or a fishing spear. It is quite obvious however, that Robinson wouldn’t survive the boat production time, as he would starve before it would be finished. The fact that he is limited by the time preference, will cause him to use hands or primitive tool, because – although less effective than a fishing boat – it will enable him to satisfy his need sooner.3

▪ High and low time preference

Time preference is always positive, but it can be high or low. To better understand high and low time preference, let’s imagine a society, with infinite time preference. In this society all consumer goods would be consumed immediately. There wouldn’t be any saving whatsoever. And for that reason, there wouldn’t be any investments in better, more effective ways of production. This kind of society, would function on a primitive level.4

We can also imagine modern society, where there are plenty of capital goods, in which people’s time preference would suddenly become infinitely high. This kind of society wouldn’t exist on a primitive level at first, because it would use previously accumulated capital. But in time, with immediate consumption of every produced good, without any savings which would allow even to maintain capital, such a society would regress in development and eventually reach existence on a primitive level.

▪ Why save and invest?

So, if a human being always prefers to get the same satisfaction sooner than later, what can encourage him to delay the consumption in time? A perspective of higher satisfaction in the future. A man with low time preference, will save and invest, to have more profits in the future. As Mises wrote:

“The sine qua non of any lengthening of the processes of production adopted is saving, i.e., an excess of current production over current consumption. Saving is the first step on the way toward improvement of material well-being and toward every further progress on this way”5.

What is this “lengthening of the process of production” Mises is writing about? It’s simply a production of the capital goods, which will allow to produce more consumer goods in the future. Let’s use an example from Paul Samuelson and William Nordhaus:

“[…] Investment in capital goods involves indirect or roundabout production. Instead of catching fish with our hands, we find it ultimately more worthwhile first to build boats and make nets—and then to use the boats and nets to catch many more fish than we could by hand.

Put differently, investment in capital goods involves forgoing present consumption to increase future consumption. Consuming less today frees labor for making nets to catch many more fish tomorrow. In the most general sense, capital is productive because by forgoing consumption today we get more consumption in the future.

To see this, imagine two islands that are exactly alike. Each has the same amount of labor and natural resources. Island A uses these primary factors directly to produce consumption goods like food and clothing; it uses no produced capital goods at all. By contrast, thrifty Island B sacrifices current consumption and uses its resources and labor to produce capital goods, such as plows, shovels, and looms. After this temporary sacrifice of current consumption, B ends up with a large stock of capital goods.

[…] Because of its thrift, Island B, using roundabout, capital-intensive methods of production, will enjoy more future consumption than Island A. […] By sacrificing current consumption and building

capital goods today, societies can increase their consumption in the future.6

The same process – although more complex – is happening when a modern company invests part of its profits in new capital goods – the machines. Its savings allow them to pay salary to the employers who construct the machine, before this machine would begin to bring any profits. Without savings (either the savings of the company itself or the people from which the company receives money from) it wouldn’t be possible.

▪ Conditions necessary for the investment to be possible

In fact, there are two conditions necessary for the investment to be possible.

The first condition is met, when people know that the investment would bring them higher satisfaction in the future, with the same amount of work. Let’s get back to the island example. If the islanders from the Island B wouldn’t know or wouldn’t believe, that the tools would allow them to consume more in the future, they would still do everything with their own hands.

The second condition is met, when people gather – by saving – enough consumer goods to allow them to satisfy all the primary needs during the time of production of capital goods. Let’s get back to our Robinson Crusoe example: Even if Robinson has materials and knowledge to build a fishing trawler, and he knows that this boat would increase his productivity, he wouldn’t build one, because he didn’t gather enough food to stay alive during the production process.

But, when both conditions are met, capital can be created and accumulated.

▪ How can you build a civilization?

We can say that time preference is one of the biggest factors that allows the development of civilization. All the investments that elevated our living standards to the current, high level, were possible due to sufficiently low time preference of our ancestors. Mises wrote:

We favorite children of the age of electricity still derive advantage from the original saving of the primitive fishermen who, in producing the first nets and canoes, devoted a part of their working time to provision for a remoter future. If the sons of these legendary fishermen had worn out these intermediary products (nets and canoes) without replacing them by new ones, they would have consumed capital and the process of saving and capital accumulation would have had to start afresh. We are better off than earlier generations because we are equipped with the capital goods they have accumulated for us”.7

Of course, not every member of the society has the same time preference. There are people with higher and lower time preference. The level of individual time preference depends on a few factors (also external factors) and it can change in time. Undoubtedly, however, a large role is played by individual psychological factors. As Hans-Hermann Hoppe writes:

“One man may not care about anything but the present and the most immediate future. Like a child, he may only be interested in instant or minimally delayed gratification. In accordance with his high time preference, he may want to be a vagabond, a drifter, a drunkard, a junkie, a daydreamer, or simply a happy-go-lucky kind-of-guy who likes to work as little as possible in order to enjoy each and every day to the fullest. Another man may worry about his and his offspring’s future constantly and, by means of savings, may want to build up a steadily growing stock of capital and durable consumer goods in order to provide for an increasingly larger supply of future goods and an ever longer period of provision. A third person may feel a degree of time preference somewhere in between these extremes, or he may feel different degrees at different times and therefore choose still another lifestyle career”.8

Nevertheless, people with low time preference contribute not only to further decrease their own time preference rate, but also a decrease of non-savers time preference rate.

Their own time preference rate is decreased because savings and investments give them higher income in the future. As Hoppe explains: “With a higher income, the marginal utility of present money falls relative to future money, the savings proportion rises, and future monetary income will be even higher”.9 To put this plainly: the more money you have, the easier is to save.

People with low time preference also decrease other peoples’ time preference. By investing they created higher demand for work. This leads to – with other things equal – higher wages. And higher wages mean more goods for those who didn’t save before.

In this way, a person with low time preference, who saves and invests, becomes the initiator of a process of civilization, who lifts himself and others, from barbarism to civilization.10

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▪ Bibliography

1 L. von Mises, Human Action, Ludwig von Mises Institute, Auburn 1998, p. 490

2 Ibid. p. 481

3 H-H Hoppe, Democracy-the god that failed, Transaction Publishers, New Brunswick, New Jersey 2007, p. 1-2

4 Ibid. p. 2

5 L. von Mises, Human Action, Ludwig von Mises Institute, Auburn 1998, p. 487

6Paul A. Samuelson, William D. Nordhaus., Economics, McGraw-Hill/Irwin, New York 2010, p. 291

7 L. von Mises, Human Action, Ludwig von Mises Institute, Auburn 1998, p. 489

8 H-H Hoppe, Democracy-the god that failed, Transaction Publishers, New Brunswick, New Jersey 2007, p. 5

9 Ibid. p. 6

10 Ibid. p. 7