Spendthrift nation
Why don't Americans save more?
NATIONAL THRIFT WEEK came and went two weeks ago, uncelebrated and unremarked. But the holiday -- once promoted by President Calvin Coolidge as a rebuke to the free-spending 1920s -- was nonetheless honored in the breach, as American prodigality was very much in the news.
Buoyed by reelection, the Bush administration has in recent weeks been pushing for tax-free "Lifetime Savings Accounts," as well as for tax reform that will shift the burden away from savings and investment and onto earnings and consumption. Even the centerpiece of the president's domestic agenda, Social Security reform, is pitched in part as a way to get Americans to save more.
Last year, after 25 years of decline, Americans' household savings rate stood at less than 1 percent of after-tax income. Japanese households, by comparison, saved 7.7 percent, while the French socked away 16 percent. Our national savings, which takes into account government and corporate savings, isn't impressive either. We save 13.6 percent of gross domestic product, compared with Japan's 25 percent and China's 50 percent. As Morgan Stanley chief economist Stephen S. Roach has warned, "America's saving problem is off the charts -- possibly the most serious imbalance in an unbalanced world."
Both as individuals and as a nation, it seems, Americans are gambling with their future. "We don't want to have the poverty rate of the elderly go back up, so it's a significant problem that people are not saving for their retirement," says Boston University economist Laurence J. Kotlikoff. And low savings exposes the country as a whole to the risk of financial crisis. As Dartmouth's Jonathan Skinner puts it, "With the low measured US savings rate, we have money flowing in to the US to be invested in US stocks and a larger share of US assets being owned by all these foreign entities. If they all decide to dump their US assets we'd be in trouble -- it would make the US dollar look like the Italian lira."
But lost in the din of dismay is the question of why Americans are such poor savers. How is it, after all, that the nation of Ben Franklin, apostle of frugality, has become a republic of spendthrifts? Should we blame a cultural proclivity or a changing economic climate, the blandishments of credit card companies or the arrogance bred of economic preeminence?
"I don't think you'll get a definitive answer from anyone you talk to," says Yale University economics professor Robert J. Shiller. In fact, it turns out that there is little consensus not only as to the root causes of our savings problem but how much of a problem it really is.
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Most economists agree that savings rates can be misleading. The household savings rate is calculated simply as after-tax income minus the amount spent on consumption. But this leaves out increases in the value of stocks or real estate, often a considerable source of wealth. In fact, selling assets at a profit often ends up depressing savings on paper, even if none of the proceeds are spent.
There are other distortions as well. Michael J. Mandel, an economist at BusinessWeek magazine, recently wrote a piece arguing against savings alarmism, pointing out that Americans' savings rates are artificially depressed by the fact that they count education spending not as investment (and therefore savings) but as consumption. Since the United States spends more of its GDP than any other country on education and research and development, he wrote, that hurts our savings rate.
Most economists agree, however, that the low American savings rate is real. The explanations they offer tend to fall into three categories: Americans don't save because they feel rich, or because they feel poor, or some paradoxical combination of the two.
The first explanation stems from the same capital gains growth missed by traditional savings measures. "Think of the late 1990s [and] the rapid run-up in the stock market, then the increase in housing values in the last few years," says MIT economist James Poterba. "We have had very big wealth changes, and households in the face of substantial increases in their wealth have cut back in the amount that they're saving." As people feel more financially secure they save less. Economists call this the "wealth effect."
But not all of them see it playing a major role. Christopher Carroll, an economics professor at Johns Hopkins University, points out that the wealth effect "doesn't seem to be a big factor across countries." Carroll instead points to national growth: "Countries like Japan that go through epochs of very fast growth tend to have savings rates that rise and rise and rise as they are growing quickly. In countries where there is a deceleration of growth compared to some historical value, the savings rates seem to fall and fall and fall."
Harvard economics professor David Laibson offers one possible explanation, almost the converse of the wealth effect. He contrasts the American economy, with its modest growth rate, with China's, where the economy is growing at 10 percent a year. "If your income is doubling every seven years you feel very flush and you're much more willing to put money aside. In America, we feel a little more pressed."
Or maybe Americans are feeling richer than they actually are. Over the past 20 years it's become extraordinarily easy to borrow in this country. As Laibson points out, "You can buy a house with little or no down payment in the US. That's impossible everywhere else in the world." And since it's also easy to take out a home equity loan, the money spent on the house isn't locked up the way it used to be. Of course, there are plenty of opportunities to borrow that don't even require collateral. They're called credit cards, and their use has exploded since the industry was deregulated in the early 1980s. "I think it has always been the case that people in the lower part of the income distribution ... would like to spend more than their income," says Johns Hopkins' Carroll. "They just haven't been able to until recently."
But Elizabeth Warren, a Harvard Law School professor and coauthor of the 2003 book "The Two-Income Trap: Why Middle-Class Mothers and Fathers are Going Broke," says the low savings rate doesn't reflect runaway consumption but the skyrocketing cost of living. "What's happened is that the cost of the basics for middle-class life have shot out of reach of the median-earning family, even in inflation-adjusted dollars," she says. "I don't think [the low savings rate] is about too many Game Boys and $200 sneakers."
Laibson, among others, is skeptical of Warren's argument, pointing out that median household wages are rising faster than inflation. (Warren counters that the data reflect the entrance of women into the workforce, a one-time bump, and that families are still spending a far bigger share of their income on big-ticket items like mortgages, health insurance, and child care than they did 30 years ago.) And some recent research has found that, at least in the past few years, the savings drop may actually be due to changes in high-income households, lending credence to the wealth-effect argument.
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But the explanation most likely to be debated in the coming months is the one offered by advocates of the president's Social Security reform plan. It's Social Security itself, they argue, that depresses American savings, and in two ways: First, there's the payroll tax that supports the program, which means, as Kotlikoff puts it, "the government is taking money from [people] that they then can't save." Then there are the benefits, which, according to William A. Niskanen, an economist and chairman of the Cato Institute, discourage people from putting away their own money for retirement.
But others say this doesn't wash, pointing out that many countries with higher taxes and more generous pension programs than ours nonetheless have higher savings rates. As Carroll points out, "[Americans] have the lowest tax rates and the lowest savings rates."
Indeed, one proven way to increase savings rates is not to give people more control over their savings, as supporters of Social Security privatization would prefer, but less. Studies by Laibson, among others, have shown that simple changes -- like changing the default option on a 401(k) plan so that employees have to opt out instead of opt in -- dramatically increases saving.
Which suggests that, as some economists argue, most of us just don't seem to be wired to save. Americans may be especially bad at it, but, says Skinner, there's a neurological basis for our tendency to privilege today's needs and desires over those of the future. "It's true with pigeons and animal studies," he says. "It's not surprising that it's true for humans."
Drake Bennett is the staff writer for Ideas. Email drbennett@globe.com. 