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U.S.: The National Piggy Bank Is Going Hungry


Americans don't save enough. You hear this warning all the time. In July, the savings rate of households fell to 0.6% of aftertax income, very close to an all-time low. But while most of the concern tends to focus on the short-term problem that skimpy savings could create for the sustainability of economic growth, it's the long-term problem that's potentially the most alarming.

Worries about a dearth of household savings have come and gone in early stages of past recoveries: Heavily indebted households, without much of a nest egg, put consumer spending at risk, especially if job growth falters. This time, it hasn't worked out that way, partly because a recovering stock market and rising home prices have boosted household wealth even faster than debt, offsetting some of these near-term concerns.

The August pickup in payrolls also should help allay some short-term worries. The Labor Dept. said jobs increased by 144,000 last month, and the gains in both June and July, while still tepid, were at least revised up a bit. The implication is that growth in consumer spending -- and the economy -- is rebounding after the second-quarter slowdown.

But in the long run, the urgency of the savings challenge stems from a basic economic fact of life: Investment, the life blood of future growth, is limited by the savings available to finance it. And it's not just the unwillingness or inability of households to sock more money away. It's also that the federal government is siphoning off a big chunk of domestic savings to fund enormous budget deficits.

THE GREAT SAVINGS DEBATE is already heating up, and it's easy to see why. The first baby boomers are only a few steps away from retirement, and the over-65 population will nearly double in the next 30 years. The coming pressure on the Social Security and Medicare systems -- and the associated demands on Washington's fiscal situation -- is too enormous to ignore any longer.

The Bush Administration is considering a host of schemes aimed at boosting savings, including tax incentives, raising the limits on individual retirement accounts, and expanding savings accounts for health-care expenses. Presidential candidate Senator John F. Kerry is proposing a plan that would help small businesses cut the administrative costs of setting up pension and other savings plans. And Federal Reserve Chairman Alan Greenspan recently weighed in with a call for more savings, noting its crucial role in helping the U.S. in the future to deal with its aging population.

Savings available for investment can be homegrown in the U.S. or borrowed from abroad. And there's the rub. In the second quarter of 2004, net domestic investment, which excludes outlays to replace depreciated equipment and buildings, totaled $922 billion. But less than one-third was financed with net domestic savings. The greater share, more than two-thirds, was made possible by net borrowings from overseas lenders.

That borrowing is roughly equivalent to the U.S. current account deficit, which comprises mainly the trade deficit, net investment income the U.S. owes to foreigners, and certain transfer payments. The Commerce Dept. will report the second-quarter current account gap on Sept. 14, and it's widely expected to hit a record 5.5% of gross domestic product.

This reliance means that, without more homegrown savings, the U.S. could get into a real bind. As Greenspan said in his speech at Jackson Hole, Wyo., on Aug. 27, "it is difficult to imagine that we can continue indefinitely to borrow saving from abroad at a rate equivalent to 5% of U.S. gross domestic product."

WHAT HAPPENS IF those foreign funds become less plentiful? Then the pressure to finance U.S. investment falls increasingly onto domestic savings. The track record in recent years is not good, but it would be wrong to put the blame totally on a lack of saving by the private sector.

In fact, during the past four years, net savings by households and businesses has increased by $234 billion, to $588 billion in the second quarter. Household savings has declined by $67 billion, to $104 billion, but savings by the business sector shot up by $301 billion, to $484 billion, as corporations' retained earnings have jumped along with the powerful recovery in cash flow.

Over the same period, however, savings by federal, state, and local governments swung from $241 billion to a negative $366 billion, reflecting a reversal of nearly $600 billion in the federal budget balance. As a result, despite the gain in private savings, overall net national savings have fallen from $595 billion four years ago, to $222 billion in the second quarter. To finance last quarter's $922 billion in net investment, foreigners ponied up the difference.

The latest forecast by the nonpartisan Congressional Budget Office offers little hope for greater government savings. Based on current law, the federal deficit will shrink from $422 billion in fiscal 2004 to $348 billion in 2005, the CBO says. Longer-term projections, however, are not encouraging, especially if Congress does not allow the provisions in the 2003 tax bill to expire. As Greenspan told Congress on Sept. 8, "the prospects for the federal budget over the longer term remain troubling."

THE MOST IMPORTANT REASON greater domestic savings is so crucial to the future is the link between investment and productivity. Productivity gains, which boost real incomes and living standards, are the best hope to generate the economic growth needed to fund commitments to retirees without placing the U.S. in fiscal jeopardy.

Even here, the road is uncertain. Greenspan notes that about half of the decade-long surge in U.S. productivity growth reflects greater investment while the other half has come from the increased efficiency with which the U.S. has invested its savings. That is, new technologies have yielded more bang for each investment buck.

But he notes that, historically, the contribution to productivity gains from additional investment dollars alone has been much larger than recently. The trouble: If the rate of technological advancement slows, it becomes more imperative that a higher level of investment take up the slack in providing strong productivity growth. But if foreign savings become less available, the Fed chairman says, "maintaining even a lower rate of capital investment growth will likely require an increased rate of domestic saving."

Recent history offers a vivid illustration. From 1995 to 1999, the years during the investment boom, net domestic savings climbed by $300 billion, the largest increase in the postwar era. But the biggest contributor was not households, not businesses, and not foreigners. It was a $340 billion turnaround in the federal budget balance from a deficit to a surplus.

The lesson for the economy's future health is clear: If Washington is intent on looking for ways to bolster household and business savings, it should consider cleaning up its own house as well.

By James C. Cooper & Kathleen Madigan


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