Will Higher Savings Help or Hurt the Economy?

What happens if Americans come out of the current downturn with a serious commitment to save more? There are many sound and obvious reasons for people to save -- to build up a cushion should they lose their jobs, for example, accumulate the down payment for a house, cover their children's college tuition, and be able to retire on more than their Social Security. Yet, over the last generation, the U.S. personal saving rate fell steadily and sharply, even reaching negative territory, as most Americans decided that the rising value of their homes or stocks could substitute for saving. And anyway, most of us simply preferred to consume more. The drawbacks became painfully clear as soon as the current crisis struck, and those home and stock values nosedived.

For now, personal saving is back, quickly turning positive and reaching 4.3 percent of people's post-tax incomes in the first quarter and nearly 7 percent in May. Businesses also are saving (i.e., they're retaining earnings) -- but not much, since hard times leave them less to save: The private saving rate, which includes businesses and households, was a little under 6 percent of national income in the first quarter. But the national saving rate is down in negative territory for the first time in generations, mainly because federal and state governments are running such big deficits -- i.e., "public dissaving." So households are rebuilding their resources, businesses are holding on, and government is using stimulus to support overall demand.

As there are risks to both families and the economy from under-saving -- our low national saving rate is what's forced us to borrow so much from China, Japan and Saudi Arabia -- high saving brings its own problems. As people save more, they have to consume relatively less, and ours is an economy run for a long-time largely on consumption. A saving rate substantially higher than we've been used to could mean slower growth and fewer new jobs, unless we maintain strong demand with large, permanent government deficits -- a bad idea for other reasons -- or much stronger business investment. Other nations also have some skin in this game of ours: More than $2 trillion of what we consumed last year came from abroad -- imports -- so weaker U.S. consumption means fewer exports and jobs in China, Germany, Japan and a lot of other places.

How we all fare with a higher saving rate will depend in part on how quickly it rises and how high it goes. Nouriel Roubini, the NYU economist who actually predicted the housing and financial market meltdowns, sees personal saving going to 10 or 11 percent, and worries especially about how a quick ascent to those levels could mean a deeper and longer recession. Most Wall Street economists, however, predict a relatively gradual increase which shouldn't impair an initial recovery -- especially since we still have most of the federal stimulus in the pipeline -- but would likely mean a slower expansion. But if the saving rate does continue to go up, it's likely to stay high for some time: Nobel economist Edmund Phelps calculates that it may take 15 years for American households to rebuild what they've lost in this meltdown. And that doesn't count the enormous debts which so many Americans carry today: In the seven years from 2000 to 2007, the debts of American households grew as much, relative to income, as they did during the previous 25 years. All of this helps explain why a majority of Americans now say they plan to keep their expenditures down after the recession ends.

The actual effect of higher saving on jobs, growth and most Americans' quality of life, however, will really depend on what happens to the incomes those savings come out of. If we return to the trends of the 2000-2007 expansion, when real wages declined and real incomes stalled, each percentage point increase in the saving rate will reduce spending by at least $100 billion. That's more than $1 trillion if we reach 10 percent and stay there (and assuming business investment doesn't soar). But if incomes rise 2 percent a year in the next expansion -- as they did through much of the 1990s -- we can save more without having to endure a long period of very slow growth.

It always comes back to incomes. It was, after all, the income slowdown since 2001 which drove up that household debt and pushed tens millions of families to spend down their home equity -- ultimately contributing to the current meltdown. And let's talk politics: Once the recession eases, what happens to wages and incomes will be the critical test of the economic success of Barack Obama's presidency and his large, Democratic majorities.

Unhappily, nothing will be harder to achieve, because restoring the broad income gains we saw in the 1950s, 1970s and again in the 1990s will require, just to begin, slowing increases in the health care and energy costs that businesses bear, and, which in a period of intense global competition come out of jobs and wages. Fortunately, the Obama Administration is focused on both of these problems. The catch is that their programs, at best, will take a decade to produce a significant slowdown in those costs. That's a long time for people to wait while their wages stagnate. But if we don't start now, those benefits will be still further off, and prospects for broad upward mobility could fade for another generation.

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