An examination of the decline in the net national saving rate since the early 1980s, which identifies an ongoing, fiscally induced wealth redistribution toward older generations and a sizable gain in annuitized forms of saving as underlying reasons.Saving and investment

Jagadeesh Gokhale

English

Research Papers in Economics

September 15, 1993
eOONOMIG
COMMeNTORY
Federal Reserve Bank of Cleveland
The Decline in U.S. Saving Rates:
A Cause for Concern?
by Jagadeesh Gokhale
A he surging federal budget deficit and
health care reform proposals have been
the subjects of choice in recent public
policy debates. Relatively little attention,
however, has been focused on another
significant and ongoing economic phe-
nomenon — the precipitous drop in sav-
ing rates in the United States. Should
this decline be a cause for concern? The
answer, of course, depends on whether
the reduction is temporary or permanent
and on whether it has the potential to se-
riously damage the U.S. economy. More-
over, if policymakers choose to address
this problem, they should understand the
underlying factors that led saving rates
to plummet beginning in the past decade.
The approach adopted here defines net
national saving as the amount of the net
national product (NNP) that remains af-
ter private and government consump-
tion spending have been subtracted.
Government consumption as a share of
NNP shows no upward trend (see figure
1). The reduction in the saving rate thus
reflects growth in the share of private
consumption.
As figure 2 shows, the net national sav-
ing rate, which averaged more than 9 per-
cent in the 1960s, dropped under 4 per-
cent in the late 1980s. For both 1991 and
1992, it came in at less than 2 percent.
Such a steep and long-term decline is
mysterious, especially because the saving
rate had remained between 8 and 9 per-
cent for a long period prior to the 1980s.
What might have caused this sharp con-
traction in national saving? This Eco-
nomic Commentary argues that demo-
graphic changes had little influence and
that future demographic changes will
probably not restore rates to their pre-
1980 levels. Today's lower saving rates
are most likely a product of fiscally in-
duced shifts in the intergenerational dis-
tribution of wealth plus growth in an-
nuitized forms of saving, which enable
higher consumption out of total wealth.
Other contributing factors may be slower
income growth and capital gains, particu-
larly on the stock of housing wealth.
• The Importance of Saving
The net national saving rate may be
viewed as a weighted sum of individ-
ual household saving rates, with the
weights representing the proportion of
NNP accruing to each household. Be-
cause income and saving are the result
of each household's own decisions re-
garding hours of work and consump-
tion, one may justifiably wonder why
low saving rates should be a cause for
concern. People would work and save
more if their own interests so dictated.
Why should policymakers be troubled
if national saving, which is just an ag-
gregate based on all households' work
and consumption decisions, falls?
The reason is simple: History has repeat-
edly demonstrated that high rates of in-
vestment and economic growth can be
sustained only on the foundation of
healthy domestic saving. First, low sav-
ing constrains the amount of investment
After averaging from 8 to 9 percent
in the previous two decades, the net
national saving rate fell precipitously
in the 1980s and early 1990s. This
long-term decline is disturbing, in
that its continued trend implies lower
ratios of capital to labor and a reduc-
tion in future productivity and wages.
In examining this phenomenon, the
author contends that an ongoing, fis-
cally induced wealth redistribution to-
ward older generations and the sizable
growth in annuitized forms of saving
may represent the major underlying
causes. Moreover, the aging of the
baby boomers may not make a signifi-
cant difference in future saving rates.
ISSN 0428-1276in productive capital that the economy
can undertake." Although the constraint
on investment may be eased through for-
eign borrowing, this cannot be a lasting
solution, because international capital
flows respond fairly rapidly to better earn-
ing opportunities elsewhere in the world.
Furthermore, although foreign investment
helps to sustain current growth in produc-
tivity and wages, it can lead to larger fu-
ture capital outflows as an increasing share
of domestic income accrues to foreigners.
A glance at the statistics reveals that net
domestic investment rates, although high-
er than rates of net national saving, have
also been on the decline (see figure 3).
Second, saving and investment connect
the present with the future. They not
only link consumption possibilities for
members of a given generation, but also
connect the economic opportunities of
members of different generations. Be-
cause individuals are at different stages
of their economic life cycles, however,
they are unlikely to have an equal stake
in the economy's future performance.
For instance, elderly and retired per-
sons will not be much affected by low
future capital-labor ratios because they
are no longer employed. On the con-
trary, these generations may gain be-
cause low future capital-labor ratios
imply higher rates of return on existing
capital assets, which older individuals
predominantly own. On the other hand,
low current saving will harm younger
generations, who will constitute tomor-
row's workforce and whose wages will
be reduced because of the resulting
paucity of capital.
• Causes of Low Saving
Demographic Change
According to the standard life-cycle
hypothesis of economic behavior, peo-
ple tend to save during their middle
years when earnings are high and then
spend those savings during retirement
when earnings are low. Thus, large de-
pendency ratios (the ratio of retirees and
children to the total population) should
be associated with lower saving rates.
FIGURE 1 GOVERNMENT AND PRIVATE CONSUMP-
TION AS A SHARE OF NNP, 1950-92
Percent
30
Percent
80
1950 1955 1960 1965 1970 1975 1980 1985 1990
SOURCE: U.S. Department of Commerce. Bureau of Economic Analysis.
FIGURE 2 NET NATIONAL SAVING RATE, 1950-92
Percent
liiillllllllllllllllllllll 0
1950 1955 1960 1965 1970 1975 1980 1985 1990
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis.
FIGURE 3 NET DOMESTIC INVESTMENT RATE,
1960-91
Percent
12
1960 1965 1970 1975 1980 1985 1990
SOURCE: U.S. Department of Commerce. Bureau of Economic Analysis.FIGURE 4 AVERAGE PROPENSITIES TO CONSUME
OUT OF WEALTH, 1991
Fraction of wealth consumed
0J0
0.25
0.20
0.15
0.10
0.05
0 00
-
-
-
-
1 I
Females
.
1 1 1
/
-—zz^-^
1 1 1 1 1 1 1 1 1
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80
Age
SOURCE: Federal Reserve Bank of Cleveland.
FIGURE 5 NET PAYMENT BURDENS FOR MALES, 1951-91
Thousands of dollars
24U
200
160
120
80
40
0
-40
-80
P0
30-year-olds
- ^, """
' "
-—
-
~ ~» _ _
•™ —- «»
—
__— " '
50-year-olds
70-year-olds ~ "- «, _ _
1951 1956 1961 1966 1971 1976 1981 1986 1991
SOURCE: Federal Reserve Bank of Cleveland.
FIGURE 6 NET PAYMENT BURDENS FOR FEMALES, 1951-91
Thousands of dollars
240 r
Indeed, cross-country comparisons of
dependency ratios and saving rates sug-
gest that this was true in the 1960s and
early 1970s/
1 In the 1980s and be-
yond, however, predicted saving rates
based on these studies were far from
the actual rates observed in the United
States and other industrial nations.
According to the predictions, private
saving rates should have risen during
this period as larger numbers of
younger workers entered the labor
force while the proportion of retirees
held fairly steady. Instead, saving rates
plummeted in the 1980s.
Evidence from microeconomic surveys
reveals that most of this decline is the re-
sult of lower saving by middle-aged and
older Americans/ Saving rates for
younger households also fell, but by
much smaller amounts. Of particular note
is that the decline cannot be attributed to
the behavior of the baby boomers, or to
changes in the fraction of income earned
by various generations. Indeed, more
than 85 percent of the shortfall in this pe-
riod stemmed from a parallel reduction
in saving rates within age groups: for
each age, saving rates in the 1980s were
less than they were in the 1960s. The de-
clines were especially large at ages 45
and over. This provides room for skepti-
cism about the prospects for increased ag-
gregate saving as the baby boom genera-
tions grow older.
The 1980s Stock Market
Boom and Capital Gains
A frequently cited explanation for
higher consumption in the 1980s is the
wealth effect of the booms in the hous-
ing sector and the stock market. Be-
cause of the stock market collapse in
1973-74, however, households probably
did not make large overall gains from
stock holdings in the 1970s. Moreover,
the boom in equity prices in the mid-
1980s occurred only after steep declines
during the 1982 recession and also after
saving rates across all age groups had al-
ready fallen. Microeconomic surveys
1951 1956 1961 1966 1971 1976 1981 1986 1991
SOURCE: Federal Reserve Bank of Cleveland.show no evidence of differential saving
behavior between owners and nonown-
ers of financial assets, yet the rise in
home values in the late 1970s and
1980s is associated with lower saving
rates for homeowners relative to non-
Fiscal Redistribution
across Generations
Data from household surveys indicate
that older individuals consume greater
fractions of their wealth than do younger
people (see figure 4). A redistribution of
resources from young to elderly genera-
tions would therefore boost total con-
sumption. Government entitlement pro-
grams — Social Security, Medicare, and
Medicaid — have been a major source of
wealth redistribution toward the elderly
over the last several decades. The extent
of this redistribution is documented in fig-
ures 5 and 6, which show the present val-
ues of prospective net payment burdens
for individuals of selected ages in each
year since 1951. Seventy-year-old
males, for example, expected to pay
more to the government than they re-
ceived in the early 1950s. Today, their net
receipts exceed $80,000 in present value,
on average. In contrast, 30-year-olds to-
day expect to pay substantially more to
the government in present value than their
same-age counterparts did in the 1950s.
Because older individuals consume larger
fractions of their wealth, this sizable
wealth redistribution toward elderly gen-
erations may be a major underlying cause
for the saving implosion during the 1980s.
Annuitization of Wealth
in the United States
The past three decades have witnessed
substantial growth in the use of annuities
as vehicles for retirement saving. Figure
7 shows how Social Security, private pen-
sions, and health insurance benefits
mushroomed from just under 4 percent
of NNP in the mid-1960s to almost 10
percent by the late 1980s. The increased
use of such annuities may constitute an-
other explanation for low saving.
FIGURE 7 SOCIAL SECURITY, PENSIONS, AND
HEALTH INSURANCE BENEFITS AS A
SHARE OF NNP, 1966-88
Percent
10
9
7
6
5
4
_
-
- ^-/
s
. . 1 . . 1 . . . . 1 . . 1 . . 1 . . 1 .
1966 1969 1972 1975 1978 1981 1984 1987
SOURCE: U.S. Department ot Commerce. Bureau of Economic Analysis.
FIGURE 8 NET NATIONAL PRODUCT, 1959-93
Percent change, s.a.a.r.
d
1959 1964 1969 1974 1979 1984 1989 1994
a. Seasonally adjusted annual rate.
SOl'RCK: U.S. Department o( Commerce. Bureau of Economic Analysis.Annuities provide individuals with in-
surance against consuming at too rapid
a rate after retirement, but paradoxically,
also permit them to consume more than
they otherwise would. Suppose, for ex-
ample, that people would consume all
of their resources if they knew in ad-
vance their precise time of death. But
given the inability to predict the length
of their lifespan and the desire to avoid
poverty during old age, these people
would be motivated to maintain a stock
of wealth until death. This wealth
would eventually become an involun-
tary bequest in the hands of younger
generations.
Now imagine that all members of a
given generation could deposit their re-
sources in a pool in exchange for annui-
ties. Under this arrangement, the re-
sources of those who died early would
be redistributed to the survivors in each
year. Because the annuity income is
guaranteed until death, each member
could consume at a higher rate than
would have been possible without ac-
cess to the annuity. Thus, consumption
out of the generation's total wealth
pool would be higher and national sav-
ing correspondingly lower.
The effect of annuitization on saving is
distinct from the effect arising from a fis-
cal redistribution of wealth toward elderly
generations: While the latter reduces sav-
ing because older individuals tend to
consume more than do younger people,
here it is the reduction or elimination of
accidental bequests that leads to higher
total consumption. An unfunded transfer
program like Social Security thus makes
both channels operative—it engenders
wealth transfers toward elderly genera-
tions and does so through the provision
of an income stream that has the same
characteristics as an annuity.
Slower Income Growth
Compared to economic growth rates of
more than 3.5 percent prior to 1970, in-
come growth has averaged 2.4 percent
since then (see figure 8). Could the
slower income gains underlie the reduc-
tion in saving rates? A slowdown in in-
come growth has two opposing effects
on aggregate saving rates. A negative
effect arises as the weights assigned to
high savers decline over time, because
their incomes now rise more slowly. A
positive effect occurs as these individu-
als save more today because they ex-
pect lower incomes in the future. Be-
cause income redistribution seems to
explain only a minor share of saving
rate changes, the positive effect should
dominate. Hence, the low income
growth in the post-1970 period should
have led to higher saving rates.
According to an alternative view, house-
holds maintain target ratios of wealth to
income at each age. If these target ratios
are unresponsive to changes in overall
income growth, then slower income
growth would imply lower wealth tar-
gets and, as a result, lower saving rates.
This prediction is consistent with the
observed simultaneous decline in in-
come growth and saving rates across
the broad cross-section of households.
• Conclusion
The sizable decline in saving in the
1980s is disturbing because continued
low levels imply lower capital-labor
ratios and a reduction in future produc-
tivity and wages. Most of the decrease
in the national saving rate can be traced
to lower saving rates within age groups,
and not much can be ascribed to changes
in income or population distribution
across age groups.
The drop in saving rates for middle-aged
and older Americans appears to be at
the root of low national saving. The fac-
tors that may have induced this decline
include the ongoing, fiscally induced
wealth redistribution toward elderly gen-
erations and the sizable growth in annui-
tized forms of saving. Low saving is also
correlated with low income growth, but
the explanation based on fixed wealth-
income ratios seems inconsistent with ra-
tional behavior. The slowdown in sav-
ing rates was particularly large for house-
holds that saw an appreciation in home
values in the 1980s.
Although older generations gain from
government transfer programs and
from the increased access to annuities,
they may save little of their gains. And
because saving rates at middle and
older ages are currently depressed, the
transition of the baby boomers into
these generations may not increase fu-
ture saving rates. Saving rates for
younger individuals have also declined
somewhat. To counteract these nega-
tive forces, and in the interest of main-
taining future productivity and wage
growth, today's younger generations
would be well advised to begin saving
a greater fraction of their incomes.• Footnotes
1. The net national product is the total na-
tional output (GNP) minus the consumption
(depreciation) of capital structures and equip-
ment. The net national saving rate is defined
as the ratio of NNP less private and govern-
ment consumption to NNP.
2. Investment in physical capital is only
part of total investment that includes invest-
ment in human capital — better education
and skills of the labor force. Here, the focus
is limited to investment in physical capital.
3. See Franco Modigliani. "The Life Cycle
Hypothesis of Saving and Intercountry Differ-
ences in the Saving Ratio," in W.A. Eltis, M.F.
Scot, and J.N. Wolfe, eds.. Induction, Growth,
and Trade: Essays in Honor of Sir Rox Harrod.
New York: Oxford University Press. 1970;
Martin Feldstein, "International Differences in
Social Security and Saving." Journal of Public
Economics, vol. 14 (1980). pp. 225-44;
Franco Modigliani and Arlie Sterling, "Deter-
minants of Private Saving with Special Refer-
ence to the Role of Social Security — Cross-
country Tests," in Franco Modigliani and Rich-
ard Hemming, eds.. The Determinants of Na-
tional Saving and Wealth, New York: St.
Martin Press, 1983; and Charles Yuji Horioka.
"Why Is Japan's Private Saving Rate So
High?" in Ryuzo Sato and Takashi Negishi.
eds.. Developments in Japanese Economics,
Tokyo: Academic Press, 1989.
4. See Barry Bosworth. "The Global Decline
in Saving: Some International Comparisons."
Brookings Discussion Papers in International
Economics, No. 83, Washington. D.C.: Brook-
ings Institution, December 1990.
5. See Barry Bosworth, Gary Burtless, and
John Sabelhaus, "The Decline in Saving:
Some Microeconomic Evidence," Brookings
Papers on Economic Activity, vol. I (1991).
pp. 183-256.
6. See Joyce Manchester and James Po-
terba, "Second Mortgages and Household
Saving," National Bureau of Economic Re-
search, Working Paper No. 2853. February
1989; and Bosworth, Burtless. and Sabel-
haus, "The Decline in Saving" (footnote 5).
7. The figures show present values of future
taxes net of transfers from federal, state, and
local governments in 1991 dollars.
8. See Bosworth. Burtless, and Sabelhaus.
"The Decline in Saving" (footnote 5).
9. Ibid.
10. Rational, forward-looking behavior would
imply an adjustment of wealth-income ratios
in the face of slower income growth.
Jagadeesh Gokhale is an economist at the
Federal Reserve Bank of Cleveland. The
author thanks William Gavin and William
Osterherg for helpful comments and Lydia
Leovic for helpful comments and excellent
research assistance.
The views stated herein are those of the
author and not necessarily those of the Fed-
eral Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve
System.
Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, Ohio 44101
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The decline in U.S. saving rates: a cause for concern?

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