Economics on Trial
IDEAS ON LIBERTY
March 2000

Will the Savings Crisis Lead to Stagnation?
by Mark Skousen

"There is a virtuous cycle in which high growth promotes high saving, and high saving in turn promotes high growth." -- Joseph Stiglitz, Chief Economist, The World Bank

"America's Expansion Cannot Be Sustained." -- The Economist, November 6, 1999

In a return to the principles of classical economics, more and more economists agree that thrift is a virtue and should be encouraged. In the textbooks, Harvard's Greg Mankiw promotes the new view toward saving: "Higher saving leads to faster growth."(1) Contrast Mankiw with the anti-saving mentality held by Paul Samuelson and other old Keynesians, who argued that higher saving may result in a recession or worse ("the paradox of thrift").

A newly released study by the World Bank reinforces this new positive outlook for saving? Under the guidance of chief economist Joseph Stiglitz, the bank came to the following startling conclusions regarding world saving:

Saving and interest rates: "The world saving rate has been declining and the world real interest rate has been increasing since the 1970s" (p. 7). Of course, saving rates vary dramatically among countries. For example, they have doubled in East Asia, stagnated in Latin America, and collapsed in sub-Saharan Africa.

Saving and income: "Long-term saving rates and income levels are positively correlated across countries" (p. 12). In other words, saving rates tend to rise with per-capita income. As people become wealthier they tend to save more. But only up to a point. The World Bank notes that saving ratios appear to level off at high levels of income.

Saving and economic growth: "Higher-saving regions have also enjoyed faster income growth." Countries that save more also grow more, although the evidence is not clear which comes first, faster growth or higher saving. In any case, they go hand in hand. Stiglitz concludes, "high saving is associated with good macroeconomic performance and sustainable access to foreign lending" (p. ix).

Saving and foreign aid: "Most [economists] conclude that aid crowds out national saving" (pp. 17-18). Given that the World Bank's purpose is to dole out foreign aid, this frank admission is amazing.

U.S. Living on Borrowed Time

Given this positive relationship between saving and economic performance, what are we to make of the sharp decline in private net saving in the United States? The latest data indicates that private net saving-the gap between disposable income and spending-has fallen to a record low of negative 5.5 percent of GDP in 1999. (See the graph below.)

Of course, millions of Americans continue to save for retirement, investment, and other reasons, but lately the debtors have outnumbered the savers. The tenuous government surplus has only partly offset the private-sector dissaving. Who makes up for the imbalance? Foreign investors (as reflected in the growing current-account deficit) are pouring billions into U. S. debt and equity securities, bank accounts, and real estate.

A recent study by two British economists, Wynne Godley and Bill Martin, warns that the United States is headed for serious trouble. They point to three unsustainable imbalances: an overvalued stock market, the collapse in private saving, and an alarming increase in debt.(3)

Other countries facing these imbalances -- Japan, Britain, and Sweden in the late 1980s -- experienced sharp slumps after asset-price bubbles burst.

What has caused the sharp drop in U.S. private net saving? Many economists blame the booming stock market, encouraging households to spend more and firms to invest more. I would add two other factors: the Bush-Clinton increases in the marginal tax rate (higher tax rates reduced disposable income, forcing households to save less) and the Federal Reserve's liberal monetary policy since the 1997 Asian financial crisis (monetary inflation has fueled the bull market on Wall Street).

Throughout the 1980s and 1990s I was bullish on the U.S. stock market. Supply-side economics and globalization kept inflation under control and the economy out of recession. Now, as we enter a new century, most trends are still positive, but we must not ignore the signs of inflation. If Ludwig von Mises and F. A. Hayek taught us anything, it is that artificial prosperity fueled by debt and monetary inflation cannot last forever. The bust is inevitable, although its severity can be offset by tax cuts, privatization of Social Security and Medicare, and expanded savings.

1. N. Greg Mankiw, Macroeconomics, 2nd ed. (New York: Worth Publishers, 1994), p. 86.
2. All citations are taken from Klaus Schmidt-Hebbel and Luis Serven, eds., The Economics of Saving and Growth (New York: Cambridge University Press, 1999).
3. "Living on Borrowed Time," The Economist, November 6, 1999.