A champion of savings over spending

by Philip Brewer on 20 February 2009 14 comments

We're subjected to constant barrage of unhelpful advice to the effect that what the economy needs is more spending. (The stimulus program is one piece of this.) It's kind of understandable: A recession is all about the downward spiral of people buying less, forcing businesses to shrink, putting people out of work, so that they spend even less. The cure, though, is not just a bunch of extra spending. The cure is to get the economy to the right size.

The right size, of course, is the size where the spending for consumption leaves a surplus that exactly matches the economy's need for investment. For decades it has been the wrong size in one direction--Americans have been spending at unsustainably high levels, saving too little to make the necessary investment in future production. The recession has caused spending to plummet, meaning that current levels of spending may well be below the long-term "right size" for the economy--the current stimulus program is an effort to get spending back up. Personally, I'm not hopeful.

For one thing, that "right size" is impossible to know. Economists try to estimate the right size by looking at shifts in the demand for money, changes in interest rates, and so on. Those sort of analyses can be useful as steps toward understanding the economy, but it's hopeless for coming up with the right answer. That's why a market economy is so much more productive than a planned economy: The analysis is simply impossible--data isn't timely or complete enough, production technology and consumer preferences are constantly changing, and planners aren't smart enough even to know all the things they ought to be planning, let alone how they all interrelate in the real world.

Fortunately, this is the area where markets work really well, if you let them. Let investors allocate resources, let consumers decide what to buy; you'll get very close to optimal resource allocations. You'll also, in the long run, get close to optimal saving and investment. Sadly, as we've seen recently, in the medium run you can get really bad levels of saving and investment.

There are a lot of bad solutions for this. In particular, having the government decide what investment is worth making is a bad solution--although maybe not as bad as what we've seen over the past 25 years or so. A much better solution is educating people to make smarter decisions. One group that's trying to do that is Choose to Save.

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I just learned about Choose to Save in a segment on last night's NewsHour on PBS. They showed clips from some hilarious public service announcements with Savingsman, a comic book hero out to rescue people from bad financial decisions. The PSA spots are available on their website, along with brochures, calculators, tips, and so on.

The NewsHour segment has a great interview with Dallas Salsbury, the founder of Choose to Save. One of the main themes of the interview was about whether it's really appropriate to chose saving over spending right now, with the economy in the shape it's in.

Fortunately, Salsbury is a great advocate for saving as a necessary step in restoring individual balance sheets to sound levels. He had some stuff to say that most people will probably find pretty tough to hear: That we probably need to spend the next decade or more deleveraging--paying off debts, building up savings, and making investments. That's how we can build the foundation to once again find some prosperity. The interview is well worth listening to.

The current stimulus program is an attempt to pull up the dip in spending between now and when individual balance sheets are at sustainable levels--to keep things from getting as bad as they might until we're back on a sound basis. The problem is the vast gulf between here and there. Unless something amazing happen with income levels, we're at least a decade away from having things cleaned up enough that we can start thinking about finding a new normal. As I've written before, debt levels are just too high.

So, don't worry that being frugal will hurt the economy. In the long run, the best thing people can do for the economy is to get their own debt levels down and saving levels up to where their personal financial situation is secure. Until then, choosing saving over spending is the right choice.

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Guest's picture

Being frugal is the right way to go. We don't need any recession scare or another economic slump just so we'll decide to be thrift and live frugal lives. Come to think of it, being frugal and staying that way will do you more good than bad. Hence, it'll help our economy if we all will be. :)

Guest's picture

Grew up on a northern Maine potato farm. If we broke even, we had a good year and get to farm again. Always, always braced for disaster weather/market wise. Get one more year out of that piece of equipment and make it last with bailing wire, duct tape or modification of another part saved for the purpose. Not wasting anything and making a game of frugality. Not cheap, frugal and living in gentile poverty..well fed, everything paid for around you and emphasis on family traditions, self relianced and appreciation for all we had. Enjoying the outdoors on a tractor not stuck in six lanes of traffic and grid lock. Gratitude is riches my mom preached. She was right. More government and trillion dollar debt with the printing presses in Washington working overtime to supply more currency, more inflation eroding the dollar's spending value is not the answer. Enjoyed your post.

Guest's picture
GTwb

Phillip,

I always enjoy your entries, they make me think about stuff I wouldn't thing otherwise. The only thing I might add is that there is a difference between an economy being optimal or one being in equilibrium. Just because the economy is in equilibrium it does not necessarily mean it's optimal. It requires a conscientious effort to nudge one from one to the other.

Philip Brewer's picture

@GTwb:

Right.  Classical economics taught that the economy would always move toward the optimal equilibrium.  Keynes's big contribution to economics was the understanding that there were suboptimal equilibriums as well.

Having said that, the peak debt paper that I shared in my post on peak debt suggests that this is really a balance sheet issue:  households are all borrowed-up.  The problem isn't that credit isn't available.  The problem is that households can't service any more debt--their incomes just won't support higher payments.

If that's true, there are only two things that are going to fix it. 

One is for households to reduce their level of debt.  That mostly has to happen by households  paying off debt, although other things--bankruptcy, debt holidays, inflation, debt forgivness programs, etc. can play a part.

The other is for household incomes to go up.  The stimulus program can help here, but it can't help enough to solve the problem.  Savings and investment leading to economic growth will help, but only over the long term.

Guest's picture
AnnieWay

Hi Philip,

I stumbled upon your site while trying to find an answer to the question thrown by this video: http://www.newsy.com/videos/u_s_changed_save_or_spend/

Growing up in Asian culture, I've always been fascinated by consumerism, thinking that this was what strengthen the U.S. economy, as opposed to Asia, where saving is more encouraged even if it thwarts the economy.

Now as world economy worsens, it's interesting to see how this Asian old wisdom of frugality becomes a fad in the States. But will this trend help or exacerbate the economy?

I still don't know for sure whether saving is better than spending or the other way around, but seems like minimizing/eliminating our own debts is what's at stake now. So, guess we've got a winner.

Guest's picture
Slinky

Nice post! Individual financial stability is very important. Normally there's a range of stability correlating more or less with age, but right now, everyone's unstable!

Guest's picture
Wilson

Good advice... until inflation hits and your savings become worthless

Julie Rains's picture

Thanks for writing this Philip -- you have articulated a few of the things I have been thinking of (simply, spend or save) and gone beyond with a sustainable solution. That our individual actions can make a collective difference has been reinforced by the current state of the economy; but what to do about it for our personal financial well-being and the economy's well-being  in order to bring stability has been the big question. I like the idea that we can promote saving and spending, in the right measures.

Guest's picture

This is the wake up call that in a year or so will be forgotten as people hit the snooze button again and forget what they should have learned . . .

lghbob's picture
lghbob

I am not optimistic about the eventual outcome of our current problems. Worse yet, I don't anticipate a recovery in my limited lifetime.
I should like to think we DO learn, and am hopeful that the problems that have occurred over the past 10 year might eventually see solutions.
My hope is that as the malaise that covers America today continues, thoughtful persons will look beyond what we know today, and what we've learned from the past, and will design a new framework for a fairer economy. An economy that has room for the entrepreneur, the investor, and the capitalist, but which also allows the rest of the country to share in the wealth that our productivity produces and what our people earn.

I hope for a rediscovery of "Binary Economics". The book from the 1950's is "The Capitalist Manifesto", by Louis Kelso.

While virtually ignored, the concept is vitually perfect.

Other than a very cursory and flawed overview from wiki, there are few sites that take time or effort to explain or analyze the concept. I would suggest that a reading of book may convince doubters, and those who are to quick to criticize what they do not understand.

One of the hardest parts of any economic model, is the introduction and transition... often preceded by war or social upheaval. Binary Economics provides a relatively painless transition, that does not include a redistribution of wealth or a heavy hand.

Overly simple, but think "profit sharing" from the 1950's. (Kelso was an initiator of ESOP, and the Capitalist Manifesto is an outgrowth of that.)

We have never had the luxury of having a period in our history, where the discontent of the people might give pause to the "in" government to stop the excesses of power. We may be at that point within another year. As America scrambles for answers, we might just seed for new growth. We have the ability... As the staus quo weakens, it's just possible that there could be a new paradigm, closer to what we knew as the American Dream.

my opinion only

Philip Brewer's picture

A well-done profit-sharing scheme is a great idea.  It has obvious benefits for workers, but also benefits for the enterprise--during bad times the cost of employment goes down automatically, without any need to cut anyone's pay.

Management, though, always screws it up.  First, they screw it up by turning it into an incentive program (with the problems that I discussed in detail in Incentive plans always go awry).  Second, they really only want to have a profit-sharing program when profits are small.  On those occasions when there are outsized profits, the managers want to shrink the profit-sharing program, figuring that the profits really belong to the owners, not to the workers (even if the workers had for years been settling for less than their fair value, in anticipation of future profit sharing).

As I say, though, if it's well done, it's a great idea.

Guest's picture
Guest

There's overcapacity in every other "asset class"

It shouldn't surprise anyone that there is much less demand for workers as well, regardless of their skill-set or experience.

I don't see real household incomes increasing up anytime in the next several years.

Most households will have to work very hard to not lose more than 20% of their current income.

Guest's picture

In some ways, more people saving more money doesn't always have to mean drastically less money circulating in the economy from spending. In essence, saving money can be viewed as delaying spending. Everyone is essentially saving for something, whether that be a new car, a new house, retirement, a vacation, etc. If this continued period of overall savings throughout the economy matures, in other words, people have been saving for long enough where their goals have been achieved, then those people will start to spend again, and then may offset the amount of people newly starting savings. This could result in more balance, once the economy adjusts, and could create a more sustainable overall economic philosophy, instead of constant rampant consumerism and excess wasteful spending.

Guest's picture
Guest

Sorry, but this piece is so utterly self-contradictory in its attempt to push an agenda that it even fails to push that agenda effectively. First you conclude that for 25 years our free market economy has utterly failed to regulate itself (as it is supposed to), leading to disaster. Then you conclude that this is why free markets are better than planned economies, which can never work? Scuse' me? Is that why the world currently proclaims the Canadian banking system the best in the world?

http://www.nytimes.com/2009/02/28/opinion/28tedesco.html?scp=1&sq=canadi...

In essence, your argument seems to be that some feeble PR campaign for Americans to save more is the key to reforming our economy. The problem with that is the free market system will outspend your "save more" campaign with it's own "spend more" campaign by a factor of about 500 to 1, as it has always done (how did we get here again?). You refuse to face the simplest fact of all, that it is the so-called free market system that very much brought about it's own downfall. And, if you factor in the amount of capital lost in this crash (still not fully tallied, gotta keep that man behind the curtain for as long as possible) over the past 25 years, I think the math will NOT show that our free market economy has been more productive than a host of more planned economies. Unless you count ponzi scheme yields are part of that productivity (which you seem to be doing).