January 19, 2004

Building the Second Gilded Age

Writing in Barrons, Martin Fridson is puzzled at the Bush administration's apparent attachment to policies to boost the national savings rate that are unlikely to do so. As Bush CEA chair Greg Mankiw puts it, in general the best way to boost the national savings rate is not to monkey with the tax code but to reduce the deficit--or even run a surplus. To me there's no mystery: the object is to tilt the distribution of wealth further in the direction of the $200,000+ a year household income crowd.

Barron's Online - Economic Beat: ...President Bush wants to institute new tax incentives to encourage people to put money away for a rainy day.... Neither is any politico likely to challenge the accepted wisdom that tax subsidies boost savings. A better-supported verdict on such programs is that they deplete the Treasury to enrich high-income individuals who would save whether offered special incentives or not.... One might nevertheless argue that the savings rate, now 2.3% of disposable income, is too low, given that the U.S. has had to rely on foreign capital to finance its investment in productivity. Unfortunately, economic research offers only tepid support for politicians' preferred solution of paying people to save. The rational first response to such a subsidy is to shift existing savings from taxable investments to the new, tax-sheltered vehicle. As former Federal Reserve Chairman Paul Volcker has observed, "If you give people a tax-exempt way to save, they will choose the tax-exempt way instead of the taxable way, but it doesn't seem to do much for the overall savings rate."

A popular college economics textbook published in 2001 points out that a savings subsidy may even backfire. The one-time Harvard professor who wrote this textbook is Gregory Mankiw. In his current job as chairman of the White House Council of Economic Advisers, Mankiw is expected to exhibit enthusiasm for the President's policies. When recently asked about Bush's aim to boost savings, though, the most emphatic comment he could muster was, "In the longer term, there are a lot of economists who argue that the national saving rate is too low." Mankiw's remark leaves it unclear whether he is among those economists. [He is] His reference to the "national saving rate" -- the sum of the public and private savings rates -- is significant, though. Conservative backlash over reduced public saving -- that is, the mounting federal deficit -- is probably the most formidable political obstacle to enactment of new savings incentives.

In his textbook, Mankiw offers a possible remedy: "Instead of trying to alter the tax code to encourage greater private saving, policymakers can simply raise public saving by increasing the budget surplus, perhaps by raising taxes on the wealthy." President Bush, however, is probably as eager to embrace that option as he is to select Dennis Kucinich as the next Secretary of Defense. Accordingly, it is possible that none of the current savings proposals will pass Congress this year, unless in a dramatically scaled-down form. That would not be an altogether undesirable outcome. Savings incentives do not necessarily generate incremental savings, but they do make the tax system more regressive. "It is an undeniable fact," writes Mankiw, "that high-income households save a greater fraction of their income than low-income households." In other words, the more a family earns, the bigger the subsidy it receives from Uncle Sam. For presidential hopefuls, raising the savings rate is an obligatory campaign promise, but one that manifestly deserves benign neglect after Election Day.

Posted by DeLong at January 19, 2004 09:29 AM | TrackBack


With the exception of Japan, cross country and cross time studies repeatedly show that savings
is largely a function of income inequality.

Yet, over the past couple of decades income inequality has risen sharply while savings
has gone down. what happened?

A study by Fed of NY last year-- sorry I do not have any more of a reference -- concluded the drop in savings has been most severe among high income individuals while savings by moderate and lower income segments had held up very well thank you.

Posted by: spencer on January 19, 2004 09:47 AM


One thing I could never understand is why investment by the companies is not counted with the savings. Earnings that are not paid out as dividends are reinvested into the companies. In fact they represent a majority of investments in US. Should we not count them together with the savings?

Posted by: Leopold on January 19, 2004 10:56 AM


They are. Only the very narrowest of savings measures omits retained earnings. And the important measure--national savings--includes both corporate retained earnings and the drain imposed by the government's budget deficit.

Posted by: Brad DeLong on January 19, 2004 11:03 AM



Please explain further. I do not quite understand the 3 passages in your intriguing post.


Posted by: anne on January 19, 2004 11:21 AM


"A study by Fed of NY last year concluded the drop in savings has been most severe among high income individuals while savings by moderate and lower income segments had held up very well thank you."

What does or might this mean?

Posted by: anne on January 19, 2004 11:23 AM


Brad writes: They are.

Cool. Thanks. But if retained corporate earnings are a part of the savings rate, it (the rate) becomes an artifact of the business cycle rather than any measure of the household savings. By the way, if employees are paid less and more earnings is retained, the "savings rate" would go up, right?

Posted by: Leopold on January 19, 2004 11:25 AM


Want people to save more? Raise interest rates.

Posted by: Andrew Boucher on January 19, 2004 12:17 PM


I guess I confused myself completely. Leaving the goverment debt aside for a moment, if the money is saved, it is invested partially into the stock market (where it just finances the Ponzi scheme) and partially left in the savings accounts (where it barely catches up with inflation). If the money is used to buy goods, it pays for the production and a part of it is reinvested as retained earnings. So I do not understand why do we want to increase the savings rate?

Posted by: Leopold on January 19, 2004 12:20 PM


Economists for Dean are linking to this Barron's article but their title suggests Mankiw was calling for a tax increase on the wealthy. That strikes me as taking what he really said out of context.

Posted by: Harold McClure on January 19, 2004 01:31 PM



The second part of oyur query is readily addressed if the accounting is in terms of changes in real wealth. Your first query assumes that one's contribution to wealth goes to some Andrew Fastow scheme and not towards new physical capital. If my savings were in this form, I could understand your question. Then again, I'm HOPING my broker has not made this mistake for me.

Posted by: Harold McClure on January 19, 2004 01:35 PM


I will go and look for the Fed of NY study.
But will be out tomorrow so can not do it until later this week.
It looked at changes in savings by income group.
It found the drop in the savings rate was
almost completely among the upper income group.

One explanation I have used for this is the stock mkt boom. If you goal is to have a portfolio
worth a certain ammount -- for example, a million dollars at retirement --you can calculate under
assumptions of average returns how much you have to place in the portfolio each year. That addition to the portfolio is out of current income and is savings. But if the return on the portfolio is above average you can use that to
reduce your annual contribution or savings out of current income. So the stock mkt boom could lead to a drop in savings among people that have savings invested in the mkt.

Of course this is how firms calculate their contributions to defined benefit programs.
I do not know how contributions to defined benefit pension plans enter into the income and
savings calculation but this may be the way
the above example actually worked through the data.

When talking about savings we need to be careful about exactly what we are talking about, personal savings or total savings that includes corporate savings. Most of the time people are talking about personal savings. That is the very low of rate 2% to 3% that is usually quoted.

total savings for most of post WW II era has averaged around 18% of GDP. It is now about 13% of GDP as both personal savings and corporate savings have fallen. Savings at about 18% of GDP is not that different from most European countries and not massively below Japanese rate.
From WW II to 1980 roughly what happened in the
US was that personal savings financed the housing mkt and business savings financed business investment with a small surplus to invest abroad.
Almost by definition if you have a current account surplus you have a surplus of savings but if you have a current account deficit you have a savings shortage.In a recession govt deficit rose and business & housing investment fell so that business & personal savings provided temporary finacing for federal deficit. System was self balancing.

Reagan created the first large scale structural federal defict that required some 10% to 20% of total private savings to finance. Foreign capital inflows largely from Japan financed the structural deficit. Under Clinton federal govt went into surplus( savings) and combo of foreign investment and govt surplus provided savings to finance some 40% to 50% of business investment during the 1990s boom.

Now, total savings -- business and personal --
around 13% of GDP and federal deficit now absorbs
about 25% of private savings. Nominal Gross private investment is also now about 15% of GDP --moderately below long term average. So we have to have foreign capital inflow of about 5% of GDP
or 25% of private savings to keep the govt deficit from crowding out private investment in housing and business capital spending.

Foreign capital inflow is about equal to 33% of gross domestic savings or 25% of domestic savings plus fed plus federal deficit. By definition current account deficit has to equal the domestic savings- investment gap. Structural federal deficit has made us higly dependent on foreign capital inflows. This is reason why in my bond model foreign interest rates now has a larger weight than fed funds and is one of reasons correlation between fed funds and T bonds rates has been under 50% since 1955 vs about 90% from 1955 to 1990.

This is reason main impact of federal deficit have worked through the dollar rather than
through higher domestic rates. but it has created a very large structural difference in the economy
from pre-1980s environment. this is why I complain biterly that mainstream economics still really looks at the US as a closed system and that no longer is true.

Posted by: spencer on January 19, 2004 01:47 PM



Sorry I do not understand you. That US stock market is a Ponzi scheme is unrelated to looting in any specific company, like Enron. But my real question is different: why do we beleive it is better to do it one way (savings-bank loans) over the other (purchase - company investements) if the money goes into production and invetsment in both cases?

Posted by: Leopold on January 19, 2004 01:54 PM


Leopold: do people think it's better? What I've always heard is that the best thing is to have a diversified portfolio of savings (that's the cliché, anyway), and put a bit of your money in bank savings, CDs, money markets, treasury bonds and other such safe things, a little of your money in real estate, a little in stocks, a little in bonds, etc, so on. Isn't that the conventional wisdom?

Hmm... how much long are we going to keep calling treasury bonds "safe?"

Posted by: Julian Elson on January 20, 2004 06:53 AM


There is a show on one of the DoItYourself channels, that, like Clarissa, explains it all. Briefly put a crew of chucker-outers goes into the home of Mr and Mrs American, filled to the brim with toys, clothes, knick knacks, Kaytel CDs, chiapets, and more. They tip the stuff into the dumpster and repaint in garish colors. Such homes are not rare. The whole culture encourages such behavior and no one who behaves that way can save a dime.

Recently one of these pack rats got caught in a stuff avalanche, and the rescue team only was able to find and dig him out after three days. A metaphor for the US economy?

Posted by: Eli Rabett on January 20, 2004 08:46 AM


"Want people to save more? Raise interest rates" writes Andrew B. That is the a simple textbook example would run. However, to the extent that higher interest rates also imply a cost for borrowers, they will have less to save, while stock values (all else equal) are likely to do less well in a high interest rate environment. Interest rate policy is also dedicated to other goals, so is unavailable for determining the savings rate, even if such a plan could work.

On the other hand, raising consumption tax rates might work well to boost savings. At least, so finds Ed Prescott (Arizona State U, advisor to Minneapolis Fed). His research finds that the tax wedge between hours worked and consumption is a very good predictor of savings rates, as well as a bunch of other stuff. The other stuff includes hours worked and the GDP growth rate. Turns out that, if you discourate consumption, you encourage savings, but also discourage work. (See minneapolisfed.org/research/wp/wp618.html.)

The Fed study Spencer mentions is, I believe, "Disentagling the wealth effect: a cohort analysis of household saving in the 1990s." It is a dandy bit of work - helps in thinking about savings and the wealth effect. See http://ideas.repec.org/p/fip/fedgfe/2001-21.html
for an abstract and ordering information.

Posted by: K Harris on January 20, 2004 09:02 AM



"Sorry I do not understand you. That US stock market is a Ponzi scheme is unrelated to looting in any specific company, like Enron."

Why is the US stock market like a Ponzi scheme?

Posted by: Barry on January 20, 2004 10:38 AM


Barry: Why is the US stock market like a Ponzi scheme?

For a good book please take a look at http://www.amazon.com/exec/obidos/tg/detail/-/0691050627/102-1794295-3657712?v=glance

But really, my question was different. I honestly do not understand why we want to rise the savings rate. The goal is to make the money work. If people spend it, it works. Why should they save it?

Posted by: Leopold on January 20, 2004 12:03 PM


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