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Commentary: Our Hidden Savings


Living beyond our means: The phrase is echoing through the halls of Washington and Wall Street, as politicians and economists try to encourage Americans to save more. Nearly every fiscal policy proposal now being floated -- including expanded tax-deferred retirement accounts, the Bush Administration's plans to overhaul Social Security, and even a possible tax reform bill -- is justified as a way to boost savings.

Certainly the numbers seem to show a savings crisis. Over the past year, the household savings rate has averaged a meager 0.8% of disposable income, the lowest level since the Great Depression. The national savings rate -- which includes corporate savings and government budget deficits -- is only about 13.6% of gross domestic product, also near a postwar low.

According to the conventional wisdom, such low savings rates threaten to undermine America's future. Weak savings means fewer funds are available to invest in productive machinery and equipment, which in turn leads to slowing long-term growth. Moreover, the argument goes, the lack of savings forces the U.S. to borrow heavily from overseas -- driving a growing trade deficit, and leaving the country more dependent on foreign funding that could dry up. And most American families seem to be shelling out far too much on cars and big homes today, rather than socking away enough for retirement.

Americans look especially imprudent when compared with their global rivals. National savings rates in Europe run around 20%, on average, while Japan saves around 25%. The International Monetary Fund estimates that China has a national savings rate of nearly 50%. Little wonder that Stephen Roach, chief economist at Morgan Stanley (MWD), recently wrote that "America's saving problem is off the charts -- possibly the most serious imbalance in an unbalanced world."

Yet the savings rate is a misleading measure of future economic performance. In today's economy, education and innovation are the main engines of wealth-producing growth, not physical capital. Yet the official statistics count spending on education and research and development as consumption, rather than as an investment.

That's a crucial distinction, since an outlay that is counted as investment ends up increasing savings. For example, if U.S. companies buy new capital equipment, that bolsters the U.S. savings rate. But if those same companies hire more scientists and boost R&D, that spending would not be counted as investment or add to savings, even though it would boost long-run growth.

It is more informative to look at what might be called the "hidden savings rate" -- the share of GDP devoted to education and R&D. By that measure, the U.S. far outperforms its major industrialized rivals. According to the latest data, the U.S. devotes 9.6% of its GDP to education and R&D. The next closest major countries are France and Canada, at 7.8% and 7.5%, respectively, followed by Germany and Japan.

Rising Asset Prices

So while other countries chide the U.S. for being profligate, Americans are putting more money into the things that matter over the long run. That's reflected in U.S. economic performance, among the strongest in the world. Both in the short run -- the past year -- and the long run -- the past 20 years -- the U.S. has had the fastest growth of the major industrialized countries.

Moreover, low personal savings has not stopped Americans from accumulating plenty of assets for retirement. Strong economic growth has lifted both housing and equity values. Over the past decade, for example, the NASDAQ is up 182% and Standard & Poor's 500-stock index is up 158%, far more than the London, Frankfurt, Paris, or Tokyo bourses. Over the same stretch, household net worth is up 67%, after adjusting for inflation and subtracting federal debt.

If the goal is to boost productivity, innovation, and growth, then government policy should emphasize spending on education and R&D, not tax measures to increase savings. That would also go a long way toward addressing concerns that the quality of U.S. education, especially at the K-12 level, is slipping compared with that of global rivals. An innovation and education-driven economy will fuel growth, keep asset values rising, and provide good returns for foreign investors.

True, a low official savings rate does require borrowing from overseas to fund consumption and investment. And this dependence, in turn, increases the vulnerability of a country if foreign investors should decide to pull out.

Still, as global capital markets become more efficient, generating internal savings is less relevant. Money flows easily across borders and searches out the highest return, which is why the U.S. has been able to easily finance its budget deficit. Moreover, appreciated assets can be sold on global markets and turned into cash.

In addition, conventional savings is like a commodity. When a European or Japanese family puts money in the bank, their euros or yen end up in the global savings pool, mixed with funds from other countries -- there's no competitive advantage.

Spending on education and R&D offers a stronger foundation for solid long-term growth. Having a large pool of college-educated workers is crucial for competing globally, for example, especially in innovative industries. According to a new report from the Organization for Economic Cooperation & Development, the U.S. spent 2.7% of GDP on higher education in 2001, while countries such as France, Germany, and Japan -- with far higher official savings rates -- spent only 1% or so of their GDP on higher ed. These countries have a much lower percentage of college grads in their labor force than the U.S, one reason why it was harder for them to take advantage of the Information Revolution. Overall, the U.S. spends 7.3% of GDP on education at all levels, the highest among the major industrialized nations. The lowest is Japan, which spends only 4.6% of GDP on education.

There are some signs that economists are looking beyond conventional measures of savings and investment. A recent paper by two researchers at the Bureau of Economic Analysis acknowledges that the national income accounts "do not treat R&D as investment and thus underestimate R&D 's contribution to national savings, the country's stock of knowledge, and the economy as a whole." And Edward C. Prescott, the 2004 winner of the Nobel Prize in Economics, along with Ellen R. McGrattan of the Federal Reserve Bank of Minneapolis, argue that ignoring "corporate intangible investments" such as R&D gives a distorted picture.

But a fascination with savings still permeates Washington. In recent years, the lack of savings has been used to justify such diverse measures as the Bush Administration's dividend tax cut, and new forms of tax-deferred accounts, such as the Roth IRA. The democrats, for their part, want to roll back Bush's tax cuts to reduce the budget deficit and increase national savings.

The coming debates over tax reform and private accounts for Social Security are going to be framed in terms of the savings rate as well. All the proposals for overhauling the tax system are geared toward putting more of the weight of taxation on consumption, and less on savings and investment. And many supporters of Social Security privatization claim that the current system lowers savings, because Americans rely on the government to fund their retirements rather than putting money away themselves.

In the end, what will propel growth is human capital and innovation. It's the hidden savings rate that deserves the attention, not the official one.

By Michael J. Mandel


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