Imagine a farm in an impoverished country, a farm where the workers are using hoes to do their work in the fields. The farm produces 1000 bushels of wheat a year, which is sold for $10,000. The farmer’s income statement reads as follows:
Crop supplies $2,000
Worker Wages $5,000
Year after year, the farm produces $1,000 bushels. The workers ask for raises but the farmer responds: “Sorry, I just cannot afford it. Until I can increase revenues, I just can’t give anyone a raise.”
Meanwhile, the workers save a bit of money each year and put it in the local bank. The farmer too saves some of his profits and puts his savings in the bank. The farmers and workers in the surrounding area do the same.
One day the farmer walks into the bank and asks for a loan of $5,000 to buy a new tractor. The banker says, “We just happen to have the $5,000 to lend you because everyone has been depositing his savings with us. Here is your loan.”
The farmer buys the tractor and returns home with it. The workers set aside their hoes and start using the tractor. The farm now produces 10,000 bushels of wheat, which is sold for $100,000.
The workers now ask for a raise. Do they need to depend on the benevolence of their employer? No because the neighboring farms are doing the same thing and experiencing the same bounty. There are also new stores opening up to cater to people who have more money at their disposal. Operating our of self-interest, all those farms and businesses compete for workers, which drives the wage rate up.
None of this would be possible without capital, which comes into existence through savings. It is savings and capital that are key to rising wage rates and higher standards of living.