A Phony Negative Savings Rate

A specter continues to haunt the U.S. economy. It is the fear that the low level of personal savings, which has turned negative for the first time since the Depression, heralds a massive retrenchment in consumption that will abruptly terminate the longest expansion in U.S. history.

Most experts link the huge slide in the savings rate from 5.6% in 1995 to -1% last quarter, to the stock market boom. As soaring stocks boosted wealth, consumers began to spend wildly on the assumption that share prices would move ever higher. Now that nearly $4 trillion in stock market capitalization has evaporated, economic Cassandras say it is only a question of time before households slash spending to get their savings back on track.

Not so, says economist Martin Barnes of the Bank Credit Analyst, an investment publication, who argues that consumers have not been on a spending binge. "Most people have not stopped saving," he says, "and that implies that coming cutbacks in spending will be far less drastic than those who focus on the negative savings rate believe."

In calculating the savings rate, notes Barnes, the government defines savings as what is left over after consumer spending is subtracted from aftertax personal income. For reasons related to accounting conventions, however, some items that households regard as income are not included in the government's income tally, while some that households ignore are. The upshot is a false picture of savings behavior.

A case in point is benefits from private pension plans, which have been growing at a 7% to 8% annual rate for years. Rather than counting such pension benefits as income (as Social Security benefits are), the statisticians count corporate contributions to pension funds. And because such contributions weren't needed as fund assets grew during the equity boom, the official measure of personal income was held down, making it appear that people were spending out of their savings.

Similarly, the government doesn't count realized capital gains as personal income because such gains are not related to income generated by current production. Yet such distinctions have little if any impact on people's behavior. Individuals tend to view capital gains as part of their incomes and to spend or save them as they see fit.

Clearly, counting pension benefits and capital gains as income alters the picture of savings behavior. Barnes calculates that such adjustments would not only add 10 percentage points to last year's savings rate but would also show little decline in savings in recent years (chart).

What's more, realized capital gains on stocks this year will still be significant, since only people who have sold stocks bought in the past two years will have losses. And people continue to rack up capital gains from sales of other assets such as homes.

All of this suggests that the negative savings rate is a red herring. "Spending should slow in response to rising unemployment and the stock market woes of the past year," says Barnes, "but not disastrously." If you are an "heir apparent" to the chief executive officer of a major corporation, you might think that your path to the top would be relatively smooth--particularly if the company is doing well. But a study in the current Academy of Management Journal suggests that aspiring top dogs often face a major hurdle in the form of a powerful incumbent CEO--unless that power is offset by the power of outside directors.

In a random sample of large manufacturers, Albert A. Cannella Jr. of Texas A&M University and Wei Shen of Rutgers University traced the fortunes of 128 chief operating officers or presidents who were at least five years younger than the incumbent CEOs of their companies. Over a 10-year period ending in 1996, they found that 65 made it to the corner office while almost half as many left. (The rest stayed put.)

What caused so many No. 2s to leave? The biggest factor was the power of the incumbent CEO, measured by such factors as corporate stock holdings and length of tenure. The more powerful the CEO, the researchers report, the smaller the No. 2 guy's chances of making it to the top and the longer the wait before promotion. And heirs apparent were especially likely to leave companies with powerful CEOs if corporate performance was high.

The path to the top was eased, however, if powerful outside directors--as measured by their number and equity investments--were on the board. Director power, the study found, lessened the likelihood of No. 2s leaving high-performing companies and raised their chances of becoming No. 1. In what major city would a two-bedroom apartment in a snazzy neighborhood cost the most in dollars? The answer, finds a survey by Global Real Estate, is London, where such an abode in Eaton Square averages about $2.12 million. Two-bedroom flats in prime neighborhoods in San Francisco, Hong Kong, New York, Amsterdam, and Stockholm range from $2 million down to $1.55 million (chart).

Such apartments, however, can differ significantly in size. While the average two-bedroom ranges from 1,400 to 2,000 square feet in tony areas in London, San Francisco, Hong Kong, and New York, for example, it jumps to a cavernous 4,800 square feet in Amsterdam's R. Wagnerstraat and a mere 860 in Paris' Saint-Germain-des-Pr?s. Thus, ranked by price per square foot, Amsterdam moves far down the list of expensive cities, while Paris jumps to 5th spot from 11th.

The Good Business Issue
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