Category Archive for: Saving [Return to Main]

Saturday, September 24, 2005

The Economist: Global Saving and Investment

The economist begins its series on explaining the pattern of global saving and investment which is intended to shed light on the low long-term interest rate puzzle with a useful summary of theories of why people save and why people invest:

What causes people to save and invest?, The Economist: At first sight, the idea of a “saving glut”—an excess of saving over investment—seems odd. According to the economics textbooks, saving and investment are always equal. ... And indeed that is true for the world as a whole, but it is not true for individual countries. ... the amount an individual country saves does not have to be the same as the amount it invests. The difference between the two is the amount borrowed from or lent to foreigners; this is called the current-account deficit or surplus... Moreover, whereas it is true that at a global level saving must equal investment, the fact that saving and investment end up in balance does not mean that ... households and individuals ... desire to save and invest in equal measure. ... Actual saving and investment must be equal. Desired saving and investment may not be.

Most of the time, ... If people's desire to save exceeds their desire to invest, interest rates will fall so that the incentive to save goes down and the willingness to invest goes up. Across borders, exchange rates have a similar effect. ... But there is some uncertainty about how smoothly these adjustments are made. Classical economic theory suggests that interest rates automatically bring saving and investment into a productive balance. The central principle of Keynesianism, however, is that this alignment between saving and investment is not always automatic, and that a misalignment can have serious consequences. ... The modern consensus is that both classical and Keynesian theory can be right, but over different time frames. In the long term, saving and investment will be brought into line by the cost of capital. But in the short term, firms' appetite to invest is volatile, and policymakers may need to step in to shore up demand. Thus, although saving and investment are equal ex-post, economic theory leaves plenty of room for an ex-ante saving glut...

What might change people's desire to save or invest? ... The most influential theory of household saving is the “life-cycle hypothesis” ... It suggests that people try to smooth consumption over their lifetime: they save little or nothing when young but more in their middle years if they have a good income. They then draw down those savings in retirement. ...demographic shifts and economic growth are the most important drivers of thrift. Another theory suggests that people save for “precautionary reasons” ... This implies that people will save more if their income is variable. It also suggests that they will be more inclined to save if they have no access to credit. A third possibility is that people save because they want to leave assets to their children, either because they love them or as a way to bribe the children to look after their parents in old age. ... the bequest theory of thrift suggests that savings might not actually be drawn down in retirement. A final possibility is that people save in response to their government's actions. This theory, known as “Ricardian equivalence”, suggests that people save more if government saves less because they expect higher taxes later on. How well do these theories fit with what has actually happened in the past? ... in general, the following factors seem to play a role:

Demographics. ...Saving rates do rise when the ratio of children in the population falls (as in China), and decline when the proportion of pensioners rises (as in Japan). Given that the world's population as a whole is ageing ... global saving should currently be rising.
Economic growth. Especially in poorer countries, saving rates rise as economies grow. That is probably because people do not adjust their consumption patterns as quickly as their income rises...
Terms-of-trade shock. If a country's exports suddenly go up in price, its saving rate tends to go up too, at least temporarily. Oil exporters, for example, put on a saving spurt if oil prices rise. This effect also helps to explain the recent increase in saving in many emerging economies.
Financial development. As an economy's financial system becomes more developed, saving rates tend to fall because people find it easier to borrow. ... It suggests that saving rates may be lower in countries with more sophisticated financial systems, such as America.
Capital gains. In rich countries ... If the stock market or house prices rise, people feel richer and save less. A study by the OECD published late last year suggests that housing wealth has a bigger effect on saving than financial wealth...
Fiscal policy. In some countries, people do appear to behave as Ricardian equivalence theory suggests: they save more when budget deficits expand, perhaps because they expect higher taxes in the future, although private-sector saving rises by less than the rise in budget deficits. The big exception is America, where the impact of fiscal deficits on private saving appears to be weakest.

Some of these factors work in opposite directions ... But there are indications that in rich countries the biggest disincentives to saving have been capital gains and the ability to borrow. ... In emerging markets, on the other hand, the most powerful factors pushed in the opposite direction. Fast economic growth and increases in government saving, thanks partly to terms-of-trade shocks, have increased total national saving. ... If there is a glut of saving, it is likely to be found in emerging economies and oil-exporting countries.

...In theory, firms should invest if the expected return on their investment exceeds the cost of the capital they are using. In the short term, firms need to worry about the state of overall demand. But in the long term, returns on capital depend on how much capital an economy already has, how productively it is used, and how fast the workforce is growing. If there is little capital available or the workforce is growing rapidly, firms would usually expect a high return on investment. The evidence supports these theories, up to a point. ... However, in recent years these statistical relationships have failed to hold. Both in rich countries and in emerging economies (except China), investment levels have been lower than economists had expected at the levels of interest and growth rates prevailing at the time. Much of Mr Bernanke's saving glut is due to this unexpectedly low rate of investment. ... several “structural” explanations have gained support:

Demographics. A young and growing workforce boosts the level of investment, just like a mature workforce boosts the saving rate. ... But although demographics are important, they change slowly. It is hard to ascribe the recent sharp drop in investment demand in regions such as Japan or East Asia to demographic change alone.
Declining capital intensity. Firms in rich countries may not need to invest as much as they used to because the share of capital-intensive industries in their economies is shrinking. ... But [this] does not explain investment busts in poor countries.
Deflation of capital-goods prices. In recent years prices of capital goods have fallen sharply relative to prices of other goods and services, thanks largely to cheaper computers, so companies are able to achieve the desired level of real investment for a smaller outlay. ... This may help to explain some of the recent weakness in investment, particularly in rich countries. But it is unlikely to last. ... More important, computers depreciate more quickly than other capital goods, so eventually firms will need to invest more to maintain the same level of net investment.
The rise of China. This may have prompted a geographic shift in global investment patterns. ... But investment flows to China from America, Europe and Japan are not yet big enough to explain the sluggish investment in those countries...

In sum, none of these explanations for a structural, global decline in investment is altogether convincing. To understand the pattern of global saving and investment properly, you have to look in detail at what is going on within the world's main saving and borrowing countries. The best place to start is the biggest net saver of all, Japan.

More to follow...

Wednesday, September 21, 2005

The Global Dearth of Investment

The Economist argues that low long-term interest rates are not due to a global glut of saving as some have claimed, but rather to a lack of global investment.  We’ve had this debate before based upon an article in The Economist, e.g. see here, particularly Brad DeLong, William Polley, PGL at Angry Bear, and this paper from the NBER. I agree with the conclusion reached at that time – low long-term rates are explained by both a lack of global investment relative to saving and by excess liquidity.  In IS-LM jargon, this is an inward shift of the IS curve and an outward shift in the LM curve as shown in DeLong.  Unlike the previous editorial in The Economist that claimed excess global liquidity explained low long-term rates, this article focuses on the inward shift in the IS:

Don’t blame the savers, The Economist:  …America’s fiscal profligacy … contribut[es] to the imbalances that currently threaten the health of the world economy. That is precisely the verdict of the newly released chapter on savings and investment in the International Monetary Fund’s World Economic Outlook. The document highlights the danger posed by the world economy’s heavy dependence on ravenous American consumers to snap up exports from the rest of the world. To be sure, it is hard to be too gloomy. … world GDP is still growing at an above-average clip. ... But dark clouds have been gathering on the horizon for some time. Emerging-market economies, particularly in Asia, are running high current-account surpluses, keeping their economic fires stoked with a steady stream of exports, especially to America. In mirror image, America’s current-account deficits have soared past 5% of GDP. Household savings have dwindled to negligible levels as Americans have run down assets and taken on debt to keep the spending binge going. Yet if the American consumer falters, as things stand now, the rest of the world will tumble too. Moreover, economists are increasingly worried that America’s economic health … rests on a housing market that looks decidedly bubbly. … But if economists are agreed that America’s debt levels are dangerous, they cannot agree on whom to blame. … the government’s profligate budget deficits … which run down national savings. …[or] … spendthrift consumers, … the frothy housing market, and … a “global savings glut” … pouring excess capital from abroad, particularly Asia, into America’s financial markets...

America is not the only country where savings have fallen. Worldwide savings began declining in the late 1990s, hitting bottom in 2002. They have recovered only modestly since then. The drop is mainly due to industrial countries, where savings and investment have been on a downward trend since the 1970s... Savings in emerging markets and oil-producing countries have risen over that period, but not enough to reverse the trend. So why the sudden talk of a savings glut? ... The IMF report offers an explanation. What the world is suffering from is not so much a savings glut as an investment deficit, in both rich and poor countries. In emerging markets and oil-exporting nations, still feeling the lingering effects of the Asian financial crisis of 1997-98, demand for capital has failed to keep up with supply. Scrimping consumers have instead sent their money to the West. The IMF’s figures suggest that this is not as irrational as it seems. … investments in emerging markets are riskier, because their economies tend to be more volatile and their institutions weaker. Moreover, … the IMF’s analysis suggests that the internal rate of return ... in emerging markets has been very poor over the past decade, even before currency risk is taken into account. But investment has fallen in the rich world too: the rivers of capital have flowed not directly into businesses but into markets for consumer and government credit, where they are presumably doing little to increase the recipient economy’s ability to repay the loans in the future… So what is the cure? Lower savings rates in emerging markets? That would be a disaster, according to a new report from the World Bank … Like the World Bank, the IMF does not think lower savings rates in developing countries are the answer. It identifies several other things that could make a difference: higher national savings in the United States, an investment recovery in Asia, and an increase in real GDP growth in Japan and Europe. Easy to say, difficult to pull off. Raising interest rates would, the IMF concedes, have only a limited effect on America’s savings rate. Balancing the budget would do more, but there seems to be little political will to tell Americans they must pay for their government programmes. Across the Atlantic, European governments are finding it hard to make the kind of structural reforms that could boost their sluggish growth rates, and the European Central Bank has remained unwilling to provide monetary stimulus by cutting rates. Nor has Japan’s government, despite the signs of fledgling recovery, yet found a formula for boosting its long-term growth rate. It is easier to diagnose the illness than effect a cure.

Tuesday, August 30, 2005

Progressive Tax Reform Democrats Can Support?

The tax reform issue is about to heat up – when congress reconvenes in September tax reform will be at or near the top of the administration’s agenda and, given the outcome of Social Security reform efforts to date, we can expect this to be undertaken with an eye towards success at most any cost. Thus, Democrats have a choice to make.  Should they try to block GOP proposals for tax reform or get out in front of the issue, if it’s not too late already, with a proposal of their own?  Given that the status quo with respect to tax burdens, shifting income distributions, and other changes is not acceptable to Democrats, and that the GOP reform proposals are not acceptable either, serious consideration should be given to a counter tax reform proposal that embodies principles of equity Democrats wish to promote.

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Tuesday, August 23, 2005

401(k) Opt-Out Regulation Proposed by Labor Department

A proposal from the Labor Department would encourage firms to automatically enroll workers in 401(k) accounts.  If enacted, it’s not clear if this will undermine the perceived necessity for Social Security reform involving add-on accounts based upon the need to increase national saving, help to open the door for more general reform, or have little effect on the political debate:

Rule would encourage automatic 401(k) enrollment, by Kathy Chu, USA Today:  The Department of Labor expects to propose a regulation by year's end that will encourage companies to automatically enroll their workers in 401(k) plans. … Once the regulation is proposed, the public will be able to comment on it before it becomes final. The regulation could affect millions of workers in 450,000 retirement plans. … The Labor Department says the proposed regulation should give employers who automatically enroll workers in a 401(k) plan some protection from lawsuits if the investment options chosen are "reasonable." Some companies are reluctant to use automatic enrollment for fear that employees whose investments lost money would sue. … Many companies that automatically enroll employees use conservative money-market or stable-value funds as a default. ... If employers view the Labor Department's guidance favorably, it could be seen as removing the last barrier to automatic enrollment … Automatic enrollment can be extremely effective in boosting 401(k) participation, especially among young and lower-income workers … Taking advantage of 401(k) plans is becoming increasingly important as companies drop pension plans…

Thursday, August 04, 2005

The Paradox of Thrift II

Samuel Brittan of The Financial Times echoes the theme of "The Paradox of Thrift" in his discussion of attempts by governments to increase saving:

Myth of national savings drives, By Samuel Brittan, Financial Times (subscription):  … Today I want to tackle the myth of national savings … we have been besieged with exhortations to save more. ... The excuse ... is the supposed need to increase physical investment. Even if we accept this “need”, the case for savings drives is not made. Between the world wars Lord Keynes pointed out that an excessive attempt to save could bring about a slump. ...  In today’s globalised economy there is another critique of savings drives. It is simply that a country’s investment is not limited by domestic savings ... There is … a fundamental worldwide “ex-ante” savings surplus. … In the present world conjuncture the last thing we need is for the US to start saving much more ... This would simply add to the very high Asian levels of savings and the moderately high continental European levels. It could then be difficult for real interest rates to fall enough to accommodate such a surge in world savings...

I want to add one note from the post linked above.  This does not rule out attempts to increase saving as a means of increasing economic security, e.g. for retirement saving, or as a means of solving potential market failure problems in these markets.  Those are separate issues.

Tuesday, August 02, 2005

The Paradox of Thrift

The marginal average propensity to save out of income was zero last month.  But wealth is still increasing due to rising home prices.  Because of this households are spending more, an average, than they are earning:

The zero-savings problem, By Chris Isidore, CNN/Money:   … Even as a government report Tuesday showed the national savings rate at zero -- that's right nada -- the rise in the value of homes has given the average U.S. household a net worth of greater than $400,000, according to a separate report from the Federal Reserve.  Household real estate assets have risen by just over two-thirds since 1999, and the run up has enabled consumers to spend more money than they are bringing home in their paychecks. … "[Rising home values] are making people feel they don't need to save," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute. … June was only the second month the rate was at zero since the monthly figure started being calculated in 1959. ...  Strong auto sales in June played a big part in the latest read on the savings rate. The government counts the entire price of the autos purchased during the month, even though most consumers pay for vehicles over time.  But even if that zero savings rate is a bit of a quirk, the trend towards lower and lower savings rates is unmistakable. In May, before the current "employee pricing" offer from automakers, the savings rate was only 0.4 percent, … As recently as 1994, the savings rate was nearly 5 percent. Go back 25 years and double-digit savings rates were the norm. … The low savings rate has kept consumers spending, which in turn has kept the economy growing.  "We've backed ourselves into a very dangerous situation," said Dean Baker, co-director of the Center for Economic and Policy Research. "The economy is dependent on everyone consuming like crazy. If everyone heard my diatribe and said, 'Yeah, we better start saving,' the economy would go into a recession." …

As noted, the cost of higher saving is lower output and employment.  But there is also, presumably, a benefit.  More saving generally leads to more investment because it reduces interest rates, and higher investment leads to more output in the future.  By giving up consumption today even more will be available in the future.  But today, with interest rates already so low, the benefit of increased saving will be less than in the past since there is unlikely to be much stimulus to investment.  Increasing national saving is a worthy goal, and it enhances economic security, but it may lead to reduced output and employment in the present without much compensation in terms of increased production in the future.

[Update: Please see Paradox of Thrift II as well].

Caution! Lobbyists at Work

Insurers are trying to ensure themselves a share of the retirement security market by lobbying for favorable legislation such as tax breaks for retirement annuities:

Insurers Want Their Say in Social Security Debate, By Joseph B. Treaster, NY Times:  … regardless of the outcome of Republican proposals to add private accounts to the system, the nation's huge life insurance industry stands to benefit from the debate over Social Security's future. Already, the debate has called attention to retirement concerns. Insurers have been increasingly focusing on selling investments for retirement and they are doing their best to capitalize on the attention. Moreover, if Congress does end up changing Social Security, there is a good chance any new law would favor the kind of investments called annuities that insurers love to sell. … [T]he insurers have strengthened their main trade association and lobbying arm, the American Council of Life Insurers, and many individual companies are working independently to win advantages for their products. Last year, the trade group alone reported spending $9.1 million on lobbying, up 54 percent from the previous year. … In making their pitch now, the insurers emphasize that their annuities can contribute to national savings and provide "a paycheck for life" similar to Social Security. They also contend that a flexible savings plan advocated by President Bush, which would probably take money away from them, would probably not increase long-term savings. And the insurers are trying to prevent the elimination of the estate tax, which many wealthy Americans now pay with the proceeds of life insurance policies. … The lobbying campaign may already be paying off. Some of the most powerful Washington leaders have been picking up on the broader issue of retirement and the woeful inadequacy of savings by most Americans…

Tuesday, July 26, 2005

Bad News for Opt-Out Accounts

This is not good news for add-on, opt-out accounts.  Younger workers, when forced to make a choice due to departure from a firm cash out their retirement saving plans in large numbers.  This implies that, when faced with checking a box on a tax return, something that requires active participation, many may opt-out and those that do may be the workers most likely to benefit from such accounts in the long-run.  Thus, the ability of these accounts to increase national saving and solve market failure problems in the retirement savings market is suspect if these statistics carry over to opt-out, add-on accounts:

Continue reading "Bad News for Opt-Out Accounts" »

Monday, July 11, 2005

Designing Optimal Opt-Out Retirement Saving Plans

This is for my records (papers on designing savings plans to maximize participation as discussed in the post below this one for the Academic Papers category I am building).  These are all by James Choi at Yale (the link is to a Harvard page, the Yale page is here):

"Optimal Defaults and Active Decisions" (with David Laibson, Brigitte C. Madrian, and Andrew Metrick). December 2004.

"Saving for Retirement on the Path of Least Resistance" (with David Laibson, Brigitte C. Madrian, and Andrew Metrick). In Ed McCaffrey and Joel Slemrod, editors, Behavioral Public Finance, forthcoming.

"Plan Design and 401(k) Savings Outcomes" (with David Laibson and Brigitte C. Madrian). National Tax Journal 57, June 2004, pp. 275-298. Summarized in October 2004 NBER Digest

"Employees' Investment Decisions About Company Stock" (with David Laibson, Brigitte C. Madrian, and Andrew Metrick). In Olivia S. Mitchell and Stephen P. Utkus, editors, Pension Design and Decision-Making Under Uncertainty, forthcoming.

"Optimal Defaults" (with David Laibson, Brigitte C. Madrian, and Andrew Metrick). American Economic Review Papers and Proceedings 93, May 2003, pp. 180-185. "Passive Decisions and Potent Defaults" is a longer version of this paper.

"For Better or For Worse: Default Effects and 401(k) Savings Behavior" (with David Laibson, Brigitte C. Madrian, and Andrew Metrick). In David Wise, editor, Perspectives in the Economics of Aging, pp. 81-121. Chicago: University of Chicago Press, 2004. Summarized in April 2002 NBER Digest

"Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least Resistance" (with David Laibson, Brigitte C. Madrian, and Andrew Metrick). In James Poterba, editor, Tax Policy and the Economy 16, 2002, pp. 67-114. Summarized in April 2002 NBER Digest

Friday, June 24, 2005

Why Do So Many Households Hold So Few Interest-Bearing Assets?

I'm not sure this post will inspire as many comments as the post below it, but increasing national saving is an important issue both generally and in the Social Security reform debate, so I thought I'd present some empirical evidence on how the accumulation of financial assets by households changes as households become more informed about financial markets. A paper by Casey Mulligan (University of Chicago) and Xavier Sala-i-Martin (Columbia University) appearing in the Journal of Political Economy, Vol. 108, No. 5. (Oct., 2000), pp. 961-991 (JSTOR stable URL – subsc.) reports that according to the Survey of Consumer Finances, 59% of U.S. households hold no interest-bearing financial assets over and above employer held pension funds and IRAs. Why do so many households hold so few assets? The authors argue that the transactions and learning costs of entering financial markets are sufficiently high so as to more than offset the expected earnings for most households. They also suggest that people with retirement fund assets such as employer held pensions and IRAs have lower transactions and learning costs because their exposure to retirement assets may bring additional understanding of how such markets function. They find that “(a) the elasticity of money demand is very small when interest rate is small, (b) the probability that any individual holds any amount of interest-bearing assets is positively related to the level of financial assets, and (c) the cost of adopting financial technologies is negatively related to participation in a pension program.”

I want to focus a bit more on (c) which tells us that participation in a pension program increases the likelihood of holding financial assets at all income levels. The Social Security debate is often centered around the idea of an ownership society for lower and middle income class workers so the focus will be on households with low amounts of financial wealth. A new econometrics textbook that will be out this fall uses data from the study to investigate this issue. The example in the book asks “How likely is an individual with $1,000 in total assets to hold any of it as interest-bearing assets if he or she has no retirement accounts?." At an asset level of $1,000 the probability (from probit estimates) that an individual will hold any of the $1,000 in interest bearing assets is 12%. However, when an individual already has a pension plan of some type, the probability of holding additional financial assets rises to 18%. Also, note that these percentages pertain to a particular asset level, $1,000, and according to result (b) the percentages increase as the asset level increases.

This is evidence that one of the barriers to entering financial asset markets is the cost of learning how they operate. This may also explain why discussions of add-on accounts have noted much higher participation rates with opt-out as opposed to opt-in programs. There is a much larger incentive to learn what you need to know to protect the principal or liquidate the assets than there is to put the assets into a retirement account. That is, if the investments are automatic or if particular funds, etc. must be chosen there is an incentive to make sure the principal is protected and to learn the rules under which the principal can be drawn down if needed. In the process needed knowledge is obtained. When the system is opt-in, the expected return is not sufficient to trigger the learning needed as a prerequisite to participation in financial markets.

Let me be clear. I believe the solvency issue has been oversold and we do not need to radically alter the Social Security program. This is in no way a call for private accounts to solve some imagined hyped-up problem. But decreasing the barriers to participation by lower and middle income households in financial markets is an important goal and this tells us something important about how to do that. As I watch colleagues fret over the very few retirement options available to them (me too), and these are Ph.D. economists, and as intelligent friends ask questions about annuities (like what the heck are they?), etc., it seems to me that these barriers are substantial.

I do not know if it is lack of knowledge of the types of financial assets, their risk-return characteristics, knowing where to go to purchase assets at the lowest fee, and so on that constitutes the biggest barrier to participation. But the change in participation rates from 12% to 18% in the numbers above at relatively low asset levels from simply having a pension account no matter how passive the participation suggests there are potential gains to be made through better education. Less than full information among participants is a known market failure, especially when information is asymmetric (why do annuities come to mind again?). My casual observation, and more to the point empirical results, suggest lack of information is a substantial problem. If we can identify and overcome areas where lack of knowledge is a barrier to participation, perhaps we can increase participation in financial markets at all income levels, particularly among low to middle class households.

What is the most important informational barrier? Is it as simple as knowing where to go to buy an asset like a T-Bill, corporate bond, or index fund? Or is it a lot more than that?

Sunday, May 22, 2005

Social Security Legislation to Include 401(k) Opt-Out Accounts

News that House Ways and Means Chairman Bill Thomas will support opt-out 401(k) accounts as a part of Social Security reform legislation:

Automatic Signup In 401(k)s Backed - Provision Eyed for Social Security Bill, By Jonathan Weisman, Washington Post: House Ways and Means Chairman Bill Thomas (R-Calif.) will include a provision in his Social Security legislation to help employers make enrollment in 401(k) plans automatic unless workers choose to opt out, according to congressional staff and knowledgeable lobbyists. The provision could have substantial impact on the nation's savings rate … Recent academic research has shown that employee participation rates soar among companies with automatic enrollment in retirement plans. … lobbyists who have met with Thomas say he has given his word on the matter.

… According to two lobbyists familiar with the discussions, Thomas has suggested to life insurance interests that he would back incentives for employers to convert 401(k) balances to private annuities that would pay out slowly over a worker's retirement. In exchange, the life insurance industry would not work against a dramatic expansion of Individual Retirement Accounts, 401(k)s and tax incentives designed to expand personal retirement savings. … Economists of all political stripes like it because it appears to work. … Mandating automatic enrollment would easily create $20 billion in new retirement savings a year, said Peter R. Orszag, director of the Retirement Security Project … If Congress pushed employers to slowly increase contribution rates over time, savings would increase well in excess of $50 billion a year. …

I’ve been wondering whether to support such a proposal. The first question I had, which I asked here, was what market failure justifies intervening to increase saving? If the loanable funds market works, wouldn’t the saving rate, whatever it is, be optimal? Through comments and an email, I am now convinced that taxes drive a wedge between private and social investment returns, that myopia might play a role, and that moral hazard may also be a problem resulting in saving below the golden rule level. Thus, I am now comfortable with government intervention to create incentives to increase private saving.

That brings me to opt-out. I believe it increases saving relative to opt-in, but why is this so? Do some people perceive the transactions costs of changing status to be greater than the benefits irrespective of whether they are asked to opt-in or opt-out? In general, I hate opt-out programs. I don’t want to spend my time filling out forms and checking boxes telling people all the things I don’t want to buy. If I’m convinced there is market failure in the market for bicycles resulting in too few being purchased, is the proper solution to drop bicycles in people’s yards unless they remember to send in the proper paperwork? I remember being in music clubs like that when I was younger… Maybe a better answer is to work a little harder on the incentives and ease of opting-in.

Last, I worry we have forgotten the Lucas critique yet again. Change the rules and change the behavior. I can imagine that if you impose opt-out now when it is uncommon participation might be high. But as it becomes more common and institutionalized people will more easily opt-out. In addition, it also seems participation rates will fall in the long-run as people hit financial stress points. If you can opt-out at will, then the first time a family faces financial distress, they will likely opt-out. Unless they are somehow brought back into the program later, participation rates will fall as time passes and revenues may not meet projected values.

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Friday, May 20, 2005

Is There Market Failure in the Loanable Funds Market?

Here's something I've been wondering about and I hope someone can help me. I hear repeatedly that the national saving rate it too low. I am not arguing against that idea, one that has been around since the mid 1990's, but why is this?

The right is a strong proponent of using Social Security reform to increase the saving rate. What market failure justifies such intervention into the private sector? Why doesn't this market produce the proper amount of saving? What market failure are those on the right, and others (many on the left embrace this as well), trying to correct in their call to increase saving through Social Security reform such as add-on accounts?

Is it due to a distortion arising from the federal budget deficit, low interest rates from Fed policy, or some other government policy? If so, why not fix the distortion rather than try and further manipulate the market to increase saving?

Before intervening, shouldn't we at least identify the market failure? And if there is no market failure, if markets always work as many believe, should we call for intervention?

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Wednesday, May 18, 2005

Evidence That Matching Funds Increase Saving

The New York Times reports the results of an experiment to see how well matching funds work as a mechanism to increase saving. The results show that matching funds cause an increase in the number of people who save and increases the average amount saved by each individual. This implies that add-on accounts with two features, government or employer matches and opt-out rather than opt-in provisions are an attractive option to pursue in reforming Social Security in a way that increases national saving. There is direct evidence that matching funds increase saving, and though the opt-out provision is not examined directly, the study does show that ease of making the contributions is important:

H&R Blockbuster, NY Times: … Half of all American households have little, if anything, saved specifically for retirement … conventional wisdom holds that there's no way to get people to save more. Happily, the conventional wisdom is wrong. … lawmakers should pay close attention to the results of an experiment that was conducted this year at 60 offices of H&R Block in the St. Louis area. From March 5 to April 5, some 15,000 H&R Block clients, most of them low- or middle-income, were offered free help setting up I.R.A.'s. They were randomly assigned to three groups: people in one group got a 20 percent match for I.R.A. contributions of up to $1,000; another group got a 50 percent match on such contributions. Still others - in the control group - were offered no matching funds. H&R Block put up the money for the matching deposits, eventually spending $500,000. The test was designed and evaluated by researchers from the Retirement Security Project, whose lead sponsor is the Pew Charitable Trusts.

The experiment generated two broad findings: First, offering a match not only causes I.R.A. participation to rise, but also increases the amounts people contribute. A total of 1,500 taxpayers chose to contribute to I.R.A.'s; participation rates were 3 percent in the control group, 10 percent in the 20 percent match group, and 17 percent in the 50 percent match group. The average contributions for the people in the match groups (not counting the H&R Block matching funds) were at least 50 percent as high as in the control group, which got no match. Second, the information provided by the H&R Block tax preparers and the ease of contributing greatly influenced the participants' decisions to save; most of the participants simply diverted portions of their tax refunds into their I.R.A.'s. Full details of how the test isolated these and other factors that bore directly on the savers' decisions are available at Although it seems like common sense that offering matching funds would increase I.R.A. participation and contributions, that hypothesis had never been rigorously tested before now. And Congress has never incorporated such direct matches into the savings incentives it provides. Instead, Congress's chief tax writer - Representative Bill Thomas of California - and most of his fellow Republican lawmakers continue to emphasize new tax-deductible savings plans and higher contribution limits for the current tax-favored accounts. Such incentives have failed in the past to motivate most taxpayers to save much, and they won't work now. A big reason for that result is that tax deductions and lofty contribution limits provide the most value to affluent, high-tax-bracket filers, not to low- and middle-income taxpayers. … Lawmakers in Washington could establish a generous and easily understandable I.R.A. match for a fraction of what it would cost to extend the Bush tax cuts for the wealthy. The evidence in favor of doing so is compelling. Then, when the ideological din abates, a future Congress can enact the reforms that are actually needed to strengthen Social Security after midcentury: modest tax increases and tempered benefit cuts, phased in over decades.

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Saturday, April 23, 2005

Social Security as Insurance vs. Welfare vs. Saving Once Again

Deinonychus antirrhopus, in this post,  revisits the "Is Social Security saving, welfare, and/or insurance question" following up on this post on the site two days before (my response to the earlier post is here). The vehicle generating the discussion is this post from my comment on a Robert Samuelson column.  My response to the latest post at Deinonychus antirrhopus is in the comments.  Brad DeLong also commented on my Samuelson post here.  In addition, Angry Bear weighs in nicely here on social insurance.

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Tuesday, April 19, 2005

Fed Governor Bies: Young Workers Face Increasing Financial Risk

Fed Governor Bies remarks on the increasing financial risk faced by young workers and their failure to take advantage of voluntary private 401(k) retirement accounts even when contributions are matched by their employers:

Remarks by Governor Susan Schmidt Bies
At the Canisius College Richard J. Wehle School of Business Community Business Luncheon, Buffalo, New York
April 18, 2005

The Economy and Managing Personal Finances

… I am expressing my own opinions, which are not necessarily those of my colleagues on the Board of Governors or on the Federal Open Market Committee…

…In the household sector, some analysts have expressed concern about the rapid growth in household debt in recent years and the decline in the household saving rate. They fear that households have become overextended and will need to rein in their spending to keep their debt burdens under control… As I have already noted, in the aggregate, household debt has grown more rapidly than income in recent years. Of special relevance to this audience is that the increase in consumer debt loads in recent years is particularly apparent among younger adults… Moreover, there are indications that some of these younger households are having difficulty managing their debt successfully… Finally, surveys continue to indicate that many workers are not currently saving for retirement, and many that are saving, by their own calculations, are not saving enough…

…Turning to retirement savings in particular, workers entering the labor force today will bear more of the risk of financial security later in life than workers of a generation ago. Far fewer workers will be covered by defined-benefit pension plans established by their employers, which provide pre-set benefits after retirement…studies have found some troubling patterns related to individual savings in 401(k) plans that suggest that workers may not be giving adequate attention to their retirement savings. First, despite the tax advantages of 401(k) contributions, one-quarter of workers eligible for 401(k) plans do not participate at all, even if the employer would match a portion of their own contributions. These workers are effectively giving up a pay raise. And among those that contribute, many save just a little. In a survey last year, one-quarter of firms reported that their rank-and-file 401(k) participants saved an average of less than 4 percent of pay…

…These patterns are troubling because they raise doubts about the financial security of workers in later life…

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Sunday, March 06, 2005

Social Security and Saving

When the government issues new debt, it seems to me that there are three possibilities to consider (assuming it is not monetized):

1. The resulting rise in interest rates causes saving to increase and consumption to decrease. Thus, one possibility is the textbook case of saving increasing because interest rates rise.

2. The fall in the price of T-Bills (rise in the interest rate) causes a movement away from substitute assets into T-Bills. There is no net effect on saving.

3. The T-Bills are purchased by the foreign sector. [The experience of the EU may be relevant (see Krugman and Obstfeld page 306, 6th ed.). In that case, a reduction in the deficit had almost no effect on national saving as savers decreased private saving to compensate. Thus, the twin deficits prediction of an increase in the current account surplus failed to materialize. As K/O note, one explanation for this is Ricardian equivalence, but it is not likely the full explanation as the empirical evidence suggests Ricardian equivalence only holds in part. K/O point to increases in household wealth as responsible for the remainder of the fall in private saving. ]

4. If households are led to believe (incorrectly and therefore irrationally) that privatization will increase the expected assets available to them at retirement, saving will decrease. I will assume rationality will prevail in the end.

Then there is risk to consider:

1. Since the government's obligations are reduced under privatization and replaced by an inflow from the stock market, people may perceive a reduction in the risk of the government meeting its obligation to pay retirement benefits. Government payments are more certain since the obligation is smaller. This reduces risk and reduces saving.

2. Since individuals are now participating in the stock market, they face more risk. This will increase their saving.

Thus, the net effect depends on people's perception of the change in risk. There is more risk from being in the market, but less risk of government default. The effect on saving depends upon the individual's perception of how these risks change.

So, it seems like the overall effect is an empirical question - it depends upon relative magnitudes, and one of the influences is difficult to measure as it depends upon people's perception of changes in risk.

I've been trying to fully understand the savings debate I'm reading. With the above as a reference point, what have I left out or stated incorrectly? What other forces affect saving, or cancel the effects noted above?

Saturday, March 05, 2005

Social Security is about insurance, not savings

[Link to actual article: Guest Viewpoint: Social Security is about Insurance, not Savings]

Guest Viewpoint: Social Security is about insurance, not savings, By Mark Thoma, Register Guard, February 24, 2005

When the Great Depression hit the United States in October 1929, the economic and social turmoil that followed exposed the typical family's need for economic security.

Workers who diligently endured the daily grind to support their families could find themselves suddenly thrown into unemployment simply because a new machine was invented, people changed their buying habits, production was relocated or the economy entered a recession.

Prior to industrialization, the need for economic security was not as great. In an agrarian economy, economic security is provided by extended family relationships coupled with the largely self-sufficient nature of farms.

Industrialization led to large economic gains, but the resulting migration to cities, the breakup of extended families, reliance on wage income as the primary means of support and an increase in life expectancy substantially increased the economic risk faced by the typical family. For a worker dependent solely on wages, the loss of a job means a total lack of income, not just hard times.

Without the help of others, abundant savings or some type of social insurance program, starvation is a real possibility. Even a worker who has assiduously saved for retirement can suddenly become impoverished due to such events as an illness or by living longer than expected.

Programs such as unemployment compensation and Social Security arose out of the Great Depression as a means to mitigate economic risk using the least amount of society's valuable resources.

Social Security was never intended to be an individual savings account. It was intended to provide a social safety net for people in retirement and families that lose a primary wage earner, and to provide the insurance at less expense than could be done privately.

People saving for their own retirement must save enough to sustain themselves should they live a long time or incur large health care costs. But this is not the optimal arrangement. Precisely the same goal can be attained with a smaller amount of savings by each individual. If everyone pools their funds, then each person needs to contribute only enough to support the average life and health expectancy of the group.

It is no different than fire insurance. Without such insurance, people would need to save enough to replace their homes should a fire break out. All risk must be borne individually, and most people end up saving far more than needed compared to an insurance program providing identical benefits. Others are left without any protection at all. With fire insurance, each person pays a smaller amount into a fund, and those unlucky few who need the insurance collect. There is no expectation that the amount paid in and the amount collected will necessarily match. Social Security insurance is no different.

But why does the government need to provide such insurance? Couldn't the private sector offer it instead to those interested in participating?

Before 1935, there was no such private insurance system available, so that is one reason to suspect the private sector will not offer such insurance. The lack of adequate pension plans offered by employers today is another.

In addition, economic theory suggests this may be an instance of market failure - that is, a case in which the private market does not provide the optimal amount of a good or service, such as insurance. Government intervention is necessary to correct the market failure.

Even if insurance is provided by the private sector, when left to provide for themselves many people do not make good decisions on saving for their retirement years. Social Security was created to solve the problems that arose when such insurance was left to the private sector.

The privatization debate has not paid enough attention to the insurance aspect of Social Security. It is social insurance, not an individual savings program, and it is important to recognize why it is optimal for government to provide social insurance collectively rather than leaving it to individuals.

Leaving it to the private sector didn't work before 1935, and there are good reasons to believe it won't work now.

Whether Social Security actually needs fixing is another debate. If it is to be fixed, anything that threatens to undermine the social safety net - and privatization is a step that pushes in that direction - also threatens the social contract the government forged with its citizens to provide for their economic security.

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