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RGE Econoblog with Sebastian Mallaby

November 15, 2005

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OK, not a true Wall Street Journal style Econoblog.   But Sebastian Mallaby of the Washington Post noted my response to his October 31st column, and has agreed to allow me to publish our email exchange.  Sebastian also has a new column out today on the (relative) absence of social mobility in contemporary America.   The money quote: "At the most selective private universities in 2003, more freshmen had fathers who were doctors than the combined total whose fathers were hourly workers, teachers, clergy or members of the military."
Our email exchange touches on many of the issues that emerged in TPM Café bookclub with Gene Sperling last week, though the focus is less on "is trade good" and more on "what policies should be put in place to manage an economy that is going global and going gray at the same time."  
Two notes.  The words in italics are all from Mallaby, but I have added a few obvious links to his text.   And the "Hacker" stuff referes to Jacob Hacker's argument that even middle income workers have less stable income streams than they did in the past.  In other words, there is a higher probability today that your annual income will move around a lot -- including fall by a lot -- than in the past.  That is a byproduct of the "churn" in today's economy.  Sebastian's original column noted this increase in volatility, and asked why it had not led to higher precautionary savings on the part of US workers.
I just noticed you did a long post about my column. While I'm flattered by the attention, I'm a bit puzzled by your angle. So in the spirit of friendly dialogue....
Most of what you state as counterargument is actually part of my premise: the Hacker stuff, fraying traditional welfare systems---this is my starting point, part of what I mean when I say that we are going gray (hence legacy costs kill traditional welfare systems tied to companies) and global (hence faster churn in the economy and the whole Hacker line). The question is, in the face of these challenges, why don't people save more? You regard volatility as an impediment to saving, but I would have thought it's at least as powerfully a reason to save.


As to the stuff on relatively stagnant wages, obviously the data since the second oil shock are well known. But there's still an interesting question---earnings, however sluggish, have nonetheless risen for nearly all households since the early 1970s, and the effect is even sharper if you go back to the 1950s or 60s. If people saved then, why is it impossible for people to save more now?
More than that, we're not talking just about low savings, but a falling savings rate. even if we disregard household income gains and disregard gains made before the second oil shock and disregard gains made by the top half of earners---ie, even if we focus only on the miserable wage performance of low-skilled individuals since 1979, why would the RATE of saving go down in the face of extra incentives to save?

Clearly your expectations point is true as a piece of description: people respond to wages that rise more slowly than expected by saving less. That's what they've done so far, but the interesting question is whether it has to be that way for all time.....anyway raising that question was the real point of my column. 

Thanks for your message.  Four points in response, one of which is rather long
1) I would need to dig more to have a definitive opinion on the sources of rising household earnings even at the low end, but it strikes me that there are three potential causes: a) women join the labor force, increasing real earnings by working more real hours, with two earner couples the new norm; b) more hours worked even by single earner households and c) rising benefit costs pushing up overall compensation but not wages.

Mallaby: Sounds right to me; but as I said, I'm willing to stipulate that household income hasn't risen as much as one would hope by a long shot. I'm not really debating why that is; I'm just observing that given slight rises, falling savings and especially a falling savings RATE is a bit mysterious. ie, i agree with your next paragraph.

2) You raise a good point on the relationship between volatility and savings, and pose an interesting puzzle.  One response to volatility is more savings and more self-insurance, and as you point out, folks could do so and still have higher household earnings (in real terms) than in the 70s. And indeed, higher savings has been a response to more volatility elsewhere: it seems to describe how say Germans have responded to a slight expected rise in income volatility associated with the pressures for reform linked to going gray and going global so to speak (Household savings in Germany are up).  It also describes how emerging markets responded to volatility in capital flows -- more savings v. investment, current account surpluses, large reserve cushions.   It even seems to describe how oil exporters have responded to expectations of large amounts of volatility in oil prices given the large move from say 1998 to September of 2005.  It just does not describe how Americans have responded -- I agree with your puzzle.

Mallaby: Good; we agree. 

3) That said, my point -- perhaps inelegantly expressed -- was that having not saved, but rather borrowed over the last say twenty years, the US worker/ consumer is poorly positioned to cope with any increase in income volatility, or even a big shift in the sectors that experience income volatility.   And as you know, my longstanding position is that what cannot go on will not go on -- at some point, there will be economic shifts that lead resources to move from housing to the tradables sector.  We won't pay for imports by exporting pieces of paper (IOUs).  But that tradables sector will still have to compete -- that shift may imply more income volatility across the economy, as even the expanding sectors are only able to expand after real restructuring and shedding some old legacy obligations/ ending future pension/ health care promises and the like ...

Mallaby: Good point; shift to more tradables will mean that Hackeresque uncertainty increases. 

4) There are several different broad public policy options for responding to changes in the economy that imply more volatility going forward (or at least no fall in volatility) and less "welfare capitalism" to soften the blow.  That includes one option put forward in the Washington Post leader that ran at the same time as your column, namely scaling back Social Security.  
In broad terms, we could:
a) Scale back public promises (to help with the public finance challenge of going gray) of retirement security.  call it paring back the public as well as the private safety net to compete better, and thus relying more on private savings.   Ironically paring back Social Security pares back our existing system of wage insurance, since Social Security protects your retirement income from periods where you don't have a job and, by virtue of being progressive, also protects against less wage income over your working life than expected because of unexpected shocks that hit your skill set/ line of work hard.  55 year olds have trouble retraining, in part because any big investment in learning a new skill set will only generate "returns" for a short period ....  shocks to income that are financed out of savings often imply fewer assets when you retire, unless, of course, expectations of those shocks leads to higher overall savings.

Mallaby: Fair enough; but remember that progressive indexing would safeguard the currently scheduled real increases in social security payouts for lower income households. So the "scale back" is actually an increase for the people you and I are most concerned about.

Setser comeback: So long as there is the US government honors the Treasury bonds Social Security holds, Social Security is safe for the next forty years without any changes.   And if progressive indexing undermines support for the program - as high earners get less back it becomes a less good deal for them - it might undermine one of the program, not save it.
b) Scale back promises of retirement security while increasing funding for
various forms of insurance that help younger folks.   Call it the Social Security for health care trade ...
c) No reduction in the public provision of retirement security, in part because the private provision of "retirement security" by companies is under threat in an economy with more job churn/ company churn.  And more public insurance for other risks --  i.e. the risk of losing health insurance when you lose a job, the risk of working for a company that does not offer health insurance and the like. This is the Krugman option --
d) Finally, one can cherry pick -- roll back parts of retirement income insurance/ health care insurance system but keep large parts of it and for example use the money that was to be spend to expand entitlements for the elderly - no prescription drug benefit -- to supply more public insurance for the working population to help cope with the churn and the like.
And of course the shadow cast over all this is that we collectively have promised more health care to our retirees than we can pay for with our current (inefficient) health care system without large increases in taxes, though I would argue, we have not promised more retirement income security through Social Security than we can pay for so long as the non-payroll taxes are raised to the levels required to honor the government's debt to the social security system.  Funding gaps after 2045 of say 1% of GDP a year (have not looked at the latest projections) don't worry me all that much; I am more worried about a country that saves 7% of GDP less than it invests when not investing all that much to begin with (particularly if you net out residential investment) with a rapidly growing external debt.
Mallaby.  I think the bottom line is that we face much higher tax burdens in the
Future because of the nature of our health commitments (see David Cutler's work, which projects health care doubling from 15 percent of GDP to more than 30 percent, with a rising share of that probably in the public sector and with the private sector part being tax-sheltered and hence hitting the budget). In that scenario, it would be nice if we can prevent tax hikes from being bigger than they would otherwise have to be. Therefore if individuals can provide for themselves in the face of some fairly obvious risks (getting sick, facing a period at some point in one's life without work, etc), that would be good. Can individuals provide for themselves? That's the hard question. They aren't doing it now. If we assume they can't do it, the moral hazard will ensure that they don't. Whether they would do it if given a few clever incentives and perhaps a culture change as people realize that globalization and associated risks aren't going away, we don't know. But it would be good to find out, since it could yield a more self-reliant, somewhat less high-tax society (albeit still a higher tax society than we've ever had in the US before) without an increase in hardship---surely something that all good Clintonites would favor? So I read this in the end as an argument for holding off on the part of the progressive agenda that advocates public wage insurance, public mortgage insurance, and other measures designed to deal with Hacker's findings on risk, but meanwhile accelerating the part of the progressive agenda that promotes savings incentives for low income folks---meaning both some tax incentives of the sort advocated by Gene Sperling in his new book and also the clever behavioral tricks to promote savings that Peter Orszag advocates--401K default check-offs, etc.
Setser comeback: I am more open to those parts of the agenda designed to  individuals cope with income volatility during their working life, in part because I think it is a relatively easy way for the winners from "going global" to compensate the losers.  Losing your job need not mean losing your health care coverage.

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