? The Next Fed Chairman: Is Conventional Wisdom Wrong? |
| Pessimist Turns Optimist ?
October 17, 2005
More and more and more savings!
I don't care much about the savings rate. I don't think it's a good indicator of future growth, and I've said so repeatedly, with lots of charts and graphs, including here.
James Hamilton, the fine UCal San Diego economist, responds to my assertion here by calculating what would happen if we increased the fraction s of income that's devoted to saving :
If the U.S. were to increase annual investment spending by $400 billion from the current $1.9 trillion, that would represent about a 20% increase in s, implying eventually 10% higher real income per U.S. resident. If one looks at the correlations across countries, one finds that countries with 20% higher values of s do indeed have on average at least 10% higher real income per person; (see for example Table 2 in "A Contribution to the Empirics of Economic Growth," by Greg Mankiw, David Romer, and David Weil in the Quarterly Journal of Economics in 1992).
Is 10% more income per person a big deal? I would say that it is, though Mandel is certainly correct that, if we had some policy that could make even a modest change in the productivity growth rate, it could potentially have a much bigger effect over time. The problem is that I'm not sure what such a policy would be.
And then he goes on to say:
Mandel is correct that we should not attempt to oversell the magnitude of the benefits that might be obtained from raising the U.S. national saving rate. But I also believe that for purposes of discussing policy options, it makes sense to focus on the variables that we can actually do something about. The U.S. budget deficit is something we could control, and I believe that we should.
Hamilton has laid out very well the conventional economic view in favor of savings. The key points of the conventional view:
1)An increase in savings will certainly have a positive effect on income per person sometime in the future.
2) Yes, "a modest change in the productivity growth rate... could potentially have a much bigger effect over time," as Hamilton says, so in theory a policy to increase productivity growth would be desirable. But Hamilton says that "I'm not sure what such a policy would be."
3) Instead, he'll go for the sure thing...cutting the budget deficit.
Let me go point by point. I'm going to accept Hamilton's calculations, even though many growth theorists now generally accept that Mankiw/Romer/Weil signficantly overstates the case for savings (One reason: They basically assume that the state of technical knowledge is the same in every country. That potentially introduces big biases, since the impact of technological differences ends up being attributed to savings and investment).
Here's my thoughts, in order.
1) Hamilton says that a 20% increase in the savings rate would increase real income per person by 10%. Unfortunately, he doesn't say how long that will take. Is it going to be 10 years, 20 years, or 30 years? It makes a difference. If it's 30 years, then the increase in growth over that stretch is roughly 0.3 percentage points.
Moreover, he also doesn't point that the real consumption per person is actually reduced by the amount of additional savings. Let's do a little bit of math. Gross private investment is roughly $2 trillion, and the combination of personal consumption and government spending is roughly $11 trillion. Call that combination total consumption.
An increase of $400 billion in savings and investment, whether by higher taxes or less government spending, would initially reduce total consumption by that amount, or about 3.6%.
If living standards are pushed down by almost 4% today, how many years does it take for Americans to be better off (taking into account the lost consumption in the early years, and summing up)? 5, 10, 15? It depends on the rate of return after depreciation.
So here's the situation. The pro-savings people are asking us to accept a sure decline in living standards today, in exchange for the possibility of a moderate increase in income somewhere off in the future. What's more, most other growth models show a lower impact of savings.
That could be a worthwhile trade-off--but only if there's no other way to do it.
2)Hamilton says he doesn't know a policy for increasing productivity growth. I've got a simple one--how about increasing government spending on basic research, especially in the area of energy technologies? Or is he assuming that current levels of government R&D spending are optimal?
3) Cutting the budget deficit is not an innocuous policy. When it comes time to slash spending, guess what's on the top of the list? You got it...R&D spending. During the budget-cutting first term of the Clinton administration, real R&D spending actually fell (see here). The same thing is going to happen as budget-cutting pressure steps up over the next year or so.
Let me repeat that. The political process is not known for subtlety. If economists keep telling politicians to cut the budget deficit, then by god they will cut the budget deficit--even if it means throwing out the baby with the bath water.
TrackBack URL for this entry:
Good grief. Hamilton would likely define investing in R&D as saving. Could you please cease and desist from mischaracterizing what other economists have said? And do see my post over at Angrybear. Also notice economist from the left (Mark Thoma) and the right (Bill Polley) agree with Hamilton's very sensible post.
Posted by: pgl at October 17, 2005 06:54 PM
I don't understand if two thirds of the economy hinges on the consumer spending at certain levels how can increased savings positively metamorphose the economy given its structure? Also I don't believe the new bankruptcy law will sustain the past levels of consumption which also poses a problem in my opinion. Let alone the 8 trillion budget deficit.
Posted by: Nicolas Valente at November 4, 2005 12:30 PM