Tuesday, August 18, 1998

'Low saving, high spending gum up economic machinery'

'The bull market has added to household wealth without the need for the usual belt tightening.'

A penny saved? Hardly

Martin and Kathleen Feldstein

AMERICANS HAVE BEEN ACCUMULATING wealth rapidly over the past decade even though they have been saving less and less of their income. The Commerce Department recently announced that the personal saving rate hit a new low in May of less than half of 1 percent of disposable (i.e., after tax) income, compared with more than 5 percent a decade ago and 9 percent in 1982. If this staggeringly low level of saving continues, there will be serious harmful effects over the longer term.

Why worry that Americans are not thrifty if their stock of wealth has nevertheless soared? To avoid confusion, lets define saving. Personal saving is the difference between after-tax income and spending on consumption. Savings include money deposited in banks and money used to purchase stocks and mutual funds. It also includes money spent to reduce debt, like paying off a mortgage. And less obviously, saving as officially defined also includes the money that employers contribute to pension funds.

The important characteristic of saving is that it is a source of new investment in productive uses. When we consume less, we leave more of national output to be invested in business plant and equipment. Sometimes that happens directly as venture capital; more frequently, it happens at the end of a chain that includes links like bank deposits, which in turn become sources of bank loans.

For the economy as a whole, total personal saving is the difference between the saving of those Americans who do put aside some portion of their income and the dissaving of those who spend more than they are earning. While some demographic groups like the baby boomers are now buying mutual funds and stocks to prepare for their retirement, for bequests, and for possible rainy days, an increasing number of newly affluent retirees are drawing down their past savings just as fast to spend on current consumption. The result is that there is almost no net saving in the economy.

Total personal saving as a percentage of disposable personal income has been declining steadily since 1992, when the current economic expansion began. People who have become wealthier through stock market gains feel freer to spend a larger portion of their current disposable income. Thats true of young and old alike. The bull market has added to household wealth without the need for the usual belt tightening. Households have become richer just as if they had reduced their consumption and put money in the bank, but without the pain of giving up current consumption.

But as always, there is no free lunch. By reducing their saving, Americans are investing less of our national output in the new plant and equipment that is critical for increasing productivity and long-term economic growth. Thats the reason for concern over the low personal saving rate.

Even before the recent decline in the saving rate, the United States had an unusually low saving rate by international standards. Many factors contributed to the low rate, including high taxes on investment income, easy and tax-favored borrowing, and generous and unfunded Social Security benefits.

Fortunately personal saving is only part of total national saving and other components have been increasing. Corporate profits not paid as dividends but available to be invested in new capital have increased substantially in recent years. And the US government has reduced its need to borrow to finance large budget deficits. The federal budget is now in surplus and is expected to remain in surplus over the next decade. That surplus this year will contribute nearly 1 percent of GDP to national saving. Capital in-flows from the rest of the world will also finance investment in plant and equipment and in housing. That source of capital investment will be about 2 percent of GDP this year. While the economy is doing just fine right now, we could do even better as a nation if the present level of saving were higher, allowing more new productive investments. Of course, the increased national saving needs to be invested wisely if it is to contribute to growth and to an increased standard of living. The drawn-out slump of the Japanese economy and the sudden collapse in Southeast Asia over the last year indicate that a high national saving rate is no guarantee of economic growth. When government rules and bureaucrats channel saving into unproductive uses and bad ventures, debacles such as have occurred in Asia will result

What protects the United States from such misuse of capital is our market-based system of channeling investments, with a heavy reliance on a well-regulated stock market and on a competitive banking system. If we as a nation can reverse the decline in the personal saving rate, we can look forward to a longer period of improved economic growth.

Martin Feldstein., the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together no economics.