During the current debate in Congress regarding whether to cut some of the planned future government spending, one of the accusations that opponents hurl at each other is that a proposed change will erode the “social safety net”. The assumption behind these accusations is that a softer social safety net is an unarguably good thing. However, I wonder if it is worth considering the possibility that the economic future for Americans overall would be brighter with a weaker welfare system.
An per-capita GDP growth rate of approximately 2 percent per year during the 20th century made the U.S. the richest country in the world in 2000. Had the growth rate been 1 percent during this period, we would have become the poorest Western country. One of the factors that leads to a higher growth rate is domestic savings, which can be reinvested in productivity-enhancing capital equipment.
Consider the public employee who knows that he or she will retire at age 50 with an inflation-adjusted pension guaranteed by a state constitution. Particularly if the pension is 90 or 100 percent of the former salary, it doesn’t make sense for that person to defer consumption today and save. Roughly the same amount of money will be coming in 20 years from now. Private-sector workers have a greater incentive to save, of course, but they don’t need to save anything for medical expenses (due to Medicare) and they can be assured of a basic income through Social Security. Workers in the high-growth Asian economies haven’t had these assurances from their governments and therefore have been saving a much higher percentage of their income (see this post, which notes that the Chinese saved 40 percent of their income during the 1990s and the number has actually risen to 45 percent more recently; this paper says the number is closer to 50 percent; the U.S. number is roughly 0 percent (source)).
To date, the U.S. has not apparently suffered too much from our lack of domestic savings (our economic growth rate right now is feeble, of course, but it doesn’t seem to be due to a lack of money to invest). A lack of stability or perceived investment opportunity in other parts of the world has led to an influx of savings from other nations. However, looking forward a few decades it seems possible that investors will have a greater range of opportunities and won’t be so keen to lend us their money at low rates. If that happens we may find that it wasn’t such a great idea to have told so many Americans that the government would take care of them.
When we hear a politician promising to enhance Medicare or Social Security, is he or she really saying “I promise to retard the future economic growth of the U.S.”?
How do you explain the behavior of European countries (e.g. Germany) with very high savings rates and much more extensive social nets? I don’t think the correlation is as simple as you make it sound.
Andrew: Excellent question. I found “Savings in Germany and the United States”, http://www.ifo.de/portal/pls/portal/docs/1/1207650.PDF (2004). It seems that the savings rate is more similar when you factor in business as well as personal. The authors claim that the labor market was more favorable in the U.S. (back in 2004 perhaps it was) and therefore people didn’t need to save as much (by this reasoning, the Chinese shouldn’t be saving anything since they have an incredibly strong labor market). The authors are economists, I suppose, and therefore end the article without any conclusion.
http://www.businessweek.com/the_thread/economicsunbound/archives/2009/02/fun_facts_about.html says that the current U.S. numbers might not be directly comparable to older numbers or foreign numbers.
http://ideas.repec.org/p/xrs/sfbmaa/01-07.html is a 2000 paper “The German Savings Puzzle” whose abstract says “Germany has one of the most generous public pension and health insurance systems of the world, yet private savings are high until old age. Savings remain positive in old age, even for most low income households. How can we explain what we might want to term the ‘German savings puzzle?’ We provide a complicated answer that combines historical facts with capital market imperfections, housing, tax and pension policies.”
We just seem to be moving the problem around. If you don’t grant pensions, prudent people save and the less prudent consume. If you grant pensions, prudent governments or corporations save and less prudent consume.
I would like some sort of social contract where we don’t have 80 year olds demonstrating products at my local big-box store, but we’re not letting bureaucrats retire at 50 with 110% of their salary.
Both of these things are happening in San Diego, where I live.
The answer is No. From your VOXEU link:
“…the declining public provision of education, health, and housing services (the breaking of the “iron rice bowl”) appears to have created new motives for saving. This can contribute to rising savings as younger households accumulate assets to prepare for future education expenditures and older households prepare for uncertain (and lumpy) health expenditures.
The inefficiency of “self-insurance” contributes to higher aggregate savings (as many households save in order to protect against a shock while relatively few may actually be hit by one). We estimate that the motive of saving for health expenditures accounts for an increase of more than 5 percentage points. The extensive privatisation of the housing stock has also contributed to savings. We estimate that saving for house purchases increased average saving rates by 3 percentage points relative to the 1990s”
High-growth Asian countries [that are also developed and usually models of good economies for you] like South Korea and Singapore, have very strong social welfare states where education, health care, and retirement are universally assured.
LT: I’m not sure about South Korea, but I think that Singapore’s way of funding retirement is a built-in savings mechanism. Unlike the U.S. Social Security system, in which current dollars are used to pay current benefits, in Singapore they put actual money aside and those savings are available for society to invest (see http://en.wikipedia.org/wiki/Central_Provident_Fund ). The same fund can be used for medical expenses. The Wikipedia page says that the combined contributions into the fund are 35.5% of wage income. So Singapore has roughly a 35 percent minimum personal savings rate by law.
http://www.nytimes.com/2009/09/13/world/asia/13silver.html says that whatever it is that the South Korean government provides to retirees, “only 28 percent of the working population is covered”. The article also says that the system was not introduced until 1988, i.e., after several of South Korea’s “tiger decades”.
Surprisingly, the answer appears to be that in practice, welfare-state programs do not negatively impact GDP growth! See this paper by Peter Lindert:
http://info.worldbank.org/etools/docs/library/139597/Lindert.pdf
With respect to national savings in particular, Canada has traditionally had a significantly higher savings rate than the US, despite having a more generous welfare state. Note that the article talking about the US having a zero savings rate is a bit out of date: it’s from 2005 (although there’s no date on the MSN copy).
http://beta.images.theglobeandmail.com/archive/00801/savingrate_801803a.jpg
Russil: Thanks for pointing out that we might need a newer source for personal savings rate in the U.S. http://research.stlouisfed.org/fred2/data/PSAVERT.txt has pretty complete data. Looks like that current rate is about 5 percent (pretty close to 0 from a Chinese perspective!). http://money.cnn.com/2010/06/30/news/economy/personal_savings_decline.fortune/index.htm has a slightly different statistic of “net national savings”. It seems not to have been above 4 percent since 1952 and recently has plummeted to 0 and below. I think this might be due to deficit spending by the federal government. However fast individual Americans are saving, the government is spending faster. So on average every American goes further into debt every year. (The accounting doesn’t include shadow deficit spending by states in the form of unfunded pension guarantees to public employees and other off-balance-sheet debt, so probably the increased indebtedness of Americans is worse than the chart shows.)
You might want to review Australia’s “defined contributions” system too. http://en.wikipedia.org/wiki/Superannuation_in_Australia There is compulsory superannuation (i.e. 401(k)) for most full-time employees, currently 9% of their ordinary earnings must be paid into a super fund on their behalf. The end result is a gigantic pool of funds that are invested back into equities and other financial products.
There is still a pension system that backstops the super system so no one is left destitute but it’s a pretty meagre lifestyle on the pension so any sane person does their best to avoid it.
“One of the factors that leads to a higher growth rate is domestic savings, which can be reinvested in productivity-enhancing capital equipment.”
Unless I’m missing something, this sounds like you’re confusing/conflating personal savings with corporate savings. Personal savings doesn’t get reinvested in “capital equipment”.
When you look at the individual level, wasn’t it spending, not saving, that grew the economy all these years? The economy is stalled out now as people spend less. Companies aren’t hiring or “investing in capital equipment” because there is no demand…
Wasn’t the housing bubble a clear enough illustration of the formula? Make people feel safe and flush and they’ll pump money into the economy as fast as they earn it-but take away the safety net (in this case the ever-soaring home values) and they’ll stop in a hurry, essentially turning off the money spigot.
If the safety net encourages spending as you claim, wouldn’t it then be a net positive for a weak economy?
And if the problem is a lack of reinvestment in business, it might be informative to look at the amount that upper management siphons off the top today, compared to the sustained growth periods of the 20th century, thanks to historic low top tax rates…
I’m not sure that the economy in 2011 needs more savings. In fact, low interest rates and the poor performance of the stock market is an unambiguous indication that the financial system doesn’t want more savings. People who ‘save’ money make Wall Street rich, they don’t necessarily make themselves rich. In fact, it seems that many on Wall Street are offended by the idea that people in the U.S. have jobs at all, so investing your money might be directly hazardous to your job and your wealth.
In my viewpoint, there’s more financial capital in existence than the system can profitably invest, so the best the system can do is blow periodic bubbles.
People who save excess money are just as reckless as those who borrow excessively because one can’t exist without the other. It’s just as irresponsible to take on a debt you can’t pay as it is to put money into a financial system which won’t be able to pay it back.
Just to take an example of the kind of deranged thinking on Wall Street, I was looking at the prospectus of a ‘2030’ fund. All the people on the board of directors are old and most of them will be dead in 2030. They’ve got this delusion that we can get to 2030 by just trying to maximize returns year after year and allocating a certain amount between fixed income and equities.
No, the way we could get to 2030 (and won’t) is by investing in the technology and institutions that we’ll need, solving global energy and security problems. If Wall Street refuses to invest for the future, it really is most rational for people to take a ‘carpe diem’ approach and spend their money today when it’s still worth something.
Or…did faux Wall-Street-scam economic growth, which led to collapse, necessitate the recent massive reliance on the social safety net, making it appear to be a greater drain on the economy than it otherwise would be?
Toby: How can personal savings be used to finance capital equipment? The traditional means by which this works is banks. Individuals deposit money in banks and the banks lend that money out to companies that can put the money to productive use. An alternative is people invest their savings in stocks offered for sale by growing companies. The companies used the capital thus raised to expand their business.
Paul: You’re probably right that we don’t need more domestic savings in 2011, since Chinese and other individuals worldwide are currently happy to lend us money. That isn’t the best long-term plan, however, and if applied in the long run it will lead to most U.S. assets being owned by foreigners (eventually they need to get a return on their investment and since we don’t export as much as we import, that means we will be transferring deeds to real estate, factories, etc.).
Burton: The Great Recession of 2008-? has not significantly affected the cost of our social programs. Our most expensive programs are age-based, e.g., public employee pensions, Social Security, Medicare. The collapse of the economy can be blamed for a lot of things, but not for making us any older.
Big corporations are sitting on a record 1.8 trillion. They aren’t investing the money to expand business, nor are they hiring.
http://www.dailyfinance.com/2010/06/21/cash-rich-companies-buying-back-shares-not-hiring-inve/
Small businesses seem like a different story, but are leaving money on the table: http://money.cnn.com/2011/07/19/smallbusiness/small_business_lending_community_banks/index.htm
Banks, on the other hand, are suffering from a lack of demand for consumer loans (especially the high-interest kind that earn them money). It doesn’t matter that a bank can borrow lots of money at 1% from consumers if it can’t then turn around and lend it for 8%+, and right now there is a massive gap where there used to be auto loans, mortgage loans, and personal finance loans. Meanwhile, the money they have in hand (which is quite a lot) isn’t being loaned because they’re waiting for rates to go up.
http://online.wsj.com/article/SB10001424052748703703304576299473313043888.html
And the stock market: the Dow has bounced back to 88% of the peak in 2007, and is already higher than it was just before Bear Stearns failure. But that doesn’t translate into jobs, obviously.
The bald fact is that a strong middle class is the basis for a healthy economy. We’ve gutted ours, which is why we have banks and companies with money and no one to buy their products. Moreover, the growth of our economy for the last 20+ years has been based as much on soaring debt spending as it has been on productivity gains. Therefore, it’s plain as day that unless we stimulate similar levels of massive debt spending, we aren’t going to see growth for a while.
But you know what, f*** it, lets just cut benefits for those hurting the most now because then they might save a little more.
Caught this too, you really need to stop conflating the macro and the micro: {http://money.cnn.com/2010/06/30/news/economy/personal_savings_decline.fortune/index.htm has a slightly different statistic of “net national savings”. It seems not to have been above 4 percent since 1952 and recently has plummeted to 0 and below. I think this might be due to deficit spending by the federal government. However fast individual Americans are saving, the government is spending faster. So on average every American goes further into debt every year.}
It clearly states in the article that the chart shows individual savings levels. Government spending is not a variable.
To quote:
“As a refresher, the basic formula used to calculate savings rate is as follows:
(Disposable Personal Income -Taxes – Expenditures = Savings) / Disposable Personal Income”
Companies that are only looking for candidates that are currently employed:
http://www.nytimes.com/2011/07/26/business/help-wanted-ads-exclude-the-long-term-jobless.htm
When people retire, do their vacated jobs become available for other workers? If the retirement age is raised, or Social Security benefits are lowered, do fewer people retire? In other words, will raising the retirement age help or hurt other people looking for jobs?
My unscientific opinion based on life experience is that the willingness to “defer compensation” over the long term is more about intelligence and/or character than about reacting to government policy.
It’s the same reason some people choose to go to college and others get a job at the local Home Depot. A bachelor’s degree is almost a guaranteed ticket to the middle class but some people don’t want to suffer through lectures, term papers, and late night cram sessions now and reap the rewards later. If you look at the current labor statistics, http://www.bls.gov/news.release/empsit.t04.htm, people with bachelor degrees or higher have a measly 4.4% unemployment rate.
Both sets of my grandparents worked and retired during a period when the viability of Social Security was never in question. Even so, they had the foresight to save and plan for other sources of income. They weren’t oil tycoons or anything. They were middle class.
I think it’s the opposite, particularly with health care. Strengthening the social safety net allows more people to consider becoming entrepreneurs.
A potential entreprenuer with a spouse & 2 kids, where private non-group health insurance is ~$20K/yr, cannot afford to leave his health-insurance providing job. Especially if someone in the family has a pre-existing condition, the child has autism, etc.
The New Deal-sparked period of strengthening social insurance from 1930s-1970s coincided with superior US economic growth. Even the Republican Presidents abided by FD Roosevelt’s social insurance policies – Eisenhower was more progressive than Clinton or Obama. The Regan era 1980 – 2011 (all Presidents since Reagan have been economic Reaganitos, witness Obama wanting to slash SS, medicare) has had lower economic growth than the 1930s-1970s era.
I do agree that some public pensions are excessive. No pension should exceed $40K at most (around the US median family income). Retirement should be at 65. If the employee is in a field like police or air traffic controller where they “can’t work” past 50 or whenever, they should be offered a retraining & transfer to another government job like the DMV or librarian, etc where they can work until age 65.
El Gringo: I agree with you that a French-, English-, or Canadian-style health care system might be a lot better for economic growth than the mess that we currently operate. However, that’s not part of the current debate, which regards how many additional $$ to toss onto the Medicare bonfire. The potential entrepreneur that you mention is not eligible for Medicare unless he is over 65. And his private health care costs have been greatly inflated by the presence of a buyer (the federal government) in the market with infinite money.
Philg,
I concede the point about Medicare buy-in/public option health insurance not being part of the current debt ceiling debate. I used an inappropriate example about having to buy 20K annual private health insurance for the entreprenuer’s famil.
My idea is that hurting the social insurance in general makes it even harder for entrepreneurs to take risk.
Let’s say the existing Medicare & SS for 65+ get slashed. Now the potential entrepreneur might need to save or have current expenses for his parent, which in some cases might be an issue of life v death for his parent. As well as save more to pay for himself & his spouse when they turn 65+ in the future. This makes it riskier to become an entrepreneur.
Philip, I just wanted to point out that you’re doing economics here, right? You’ve got a model of people’s behavior in which people do “consumption smoothing”: if they know that they will have large expenses in the future (e.g. medical expenses), they will consume less now and save more.
In fact, if you look at the Wikipedia article on consumption smoothing, you’ll find that there isn’t much evidence that people do consumption smoothing! People aren’t very far-sighted; their consumption level depends on their currently available income.
An example:
http://www.rau.ro/intranet/Aer/1999/8904/89040959.pdf
If people don’t plan ahead, this would tend to support mandatory retirement savings schemes, whether defined-contribution (like Singapore and Australia) or defined-benefit (like Canada).
Phil, you’re sure right about the feds’ driving up the cost of private health care. I think the growth of employer-provided health coverage has also driven the cost way up. Back when I was a kid in the halcyon 1950’s, my parents paid the doctor bills for ordinary visits; the insurance covered a % of hospital costs, surgery, etc., i.e., the big and/or extraordinary costs. Ike was a big promoter of catastrophic health care coverage, so people wouldn’t be wiped out. But the coverage of everything, including visits to the doc anytime one wants to get that head cold checked out, means we’re all paying (well, those of us who ARE paying) directly or indirectly for all those unneeded visits. And, although I’m a believer in the First Amendment right of commercial speech by corporations, I think the TV advertising by drug companies, when combined with the concomitant “right” of everyone to the most expensive drugs available, even if they don’t really work more than a tad better than the generics, has helped to drive health care costs through the roof.
An import social impact that’s being over looked (or not being emphasized enough in my opinion) is the idea of “shifting responsibility”.
If a government guaranties security and owns the welfare of its citizen, more citizens will depend on government and thus be less self sustained. I.e.: why a young adult should worry about his health if the government guaranties healthcare for him/her? Why a middle age adult, who is nearing retirement think about saving when government has guaranteed retirement or welfare? Those are just some examples, that take responsibility away from individuals.
Such “free gimmicks”, when offered by a government, will impact overall productivity and innovation (not to mention survival skills) which results with hurting the economy and in turn the nation.
Foreigners immigrated to the US not because of guaranties or safety-nets the US government offers — we hardly had any of this — but because of freedom *from* government (read: less government) to make it in America as an individual.
In order to save, the middle class needs to see real improvement in earnings. The “safety net”, which includes Social Security, Medicare, and unemployment insurance, does not cover all costs in retirement or disability. If Americans were properly informed, they would realize the need to save. Our economy and our culture are based on rising consumption, not savings. In the current economy, earnings are not keeping up with inflation. The stagnation in earnings in the face of rising prices for energy and food have combined to eat up monies that could be going into savings. This sketchy theory that the social safety net inhibits saving does not stand up. At some point in the future this theory might have a limited amount of relevance. Without rising earnings and wages the theory is moot.