How Savings Affect the Economy?

Economics is divided on the role of savings. Many economists believe that saving is a personal virtue but social vice. This is because if all the people start saving, the expenditure will go down. Since the current system measures GDP and economic growth based on expenditure, a higher savings rate makes it appear like the economy is not growing. In fact, it may appear like the economy is about to enter a recession.

On the other hand, many economists do acknowledge that this GDP based view of savings is incorrect. They refer to the unanimity in all of economic history. No country in the world has achieved economic prosperity without having a high savings rate. Right from the United States to China, any country that has reached the peak of global finance has been largely powered by their high savings rate.

In this article, we will have a closer look at the concept of savings and how it affects the individual as well as the economy.

The Dire State of Savings Rate in the United States

Americans used to save a lot of money till the 1970’s. However, in the recent past, they seemed to have fallen out of the savings habit. The Bureau of Economic Research has declared that the savings rate in America has fallen to a meager 3.8% in 2017! This means that over three-quarter Americans do not have the wherewithal to sustain for even six months in the event of a personal emergency like a job loss or any health issues. To make matters worse, the population is aging. This means that there will be more people withdrawing from their savings. Hence, the national savings rate is likely to deteriorate to 3% by 2030.

The numbers provide a clear story. Americans will have a tough choice to make. A lot of them may have to work longer than the sixty-five-year retirement age in order to have the financial capability to sustain during retirement. The other alternative is to have a significantly lower standard of living. They also run the risk of running out of money completely if any health issues arise.

Surveys have revealed that most people who are retiring expect the government to take care of them. It is for this reason that there has been a push towards socialistic policies. Americans now vote for the idea of welfare state instead of the capitalistic ideology that they were once known for. The implication of this is that the United States government could face a welfare crisis. At the present moment, the government provides unemployment income and medical benefits to its citizens.

Savings Rate and Income Tax Policy

The income tax policy of the United States has been discouraging saving by reducing the incentive to save. The reason is that policymakers often get caught between long-term and short-term objectives. In the long run, they would like to see the individuals become more self-sufficient. However, in the short run, they fear that the economy would spiral into a recession if savings were done more aggressively.

The bottom 25% of the income earners need to save the maximum. According to the survey by the Bureau of economic research, they need to save twenty-one percentage points more! The second lowest quartile needs to save eight percentage points more. However, the top two quartiles are not in dire needs of savings.

It is therefore essential that the tax policy be created in such a way that the bottom two quartiles have the incentive to increase their savings. If the government focuses on tax collection now, they may have to pay a significantly higher amount in welfare payments shortly

The problem is that plans like 401(k) incentivize the top earners to save their income. However, these plans are expensive and therefore only provided by large employers. The government needs to come up with an alternative to these plans which can be provided by small businesses as well. Most of the employees working for small businesses have a dismal savings rate. The government needs to create incentives for improvement of this rate.

Savings Rate and the Government

We also need to understand that savings rate is not necessarily bad for the government. This is because right now the United States is highly dependent upon China to fill the savings gap. They need to constantly borrow money from China to fund the current account and fiscal deficit.

The high dependence on Chinese capital is a threat the American economy. This is because there is a chance that the Chinese may suddenly decide not to lend to America. This could have an adverse impact on the economy.

If the savings rate of the United States household were to increase substantially, the reliance on foreign capital would reduce drastically. Hence, an increase in the household savings rate is good both for the government and for the people. The problem is that the government is too caught up in short-term objectives to see what is actually important in the long run.