Arnold Kling  

The Need for Savings

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In this essay, I argue that because people live longer and consume more health care, we should be saving more.


Suppose that 50 years ago the expectation for a 45-year-old man was that he would live to age 70, and that health care costs would be, in today's terms, $1000 per year after retirement, at age 65. Today, a 45-year-old man might expect to live to age 85, with health care costs averaging $10,000 per year. Assume that other post-retirement living expenses are $30,000 per year. The total post-retirement expenses are compared in the table below.

Expense Driver50 years agoToday
Average annual health cost$1000$10,000
Other annual expenses$30,000$30,000
Total annual expenses$31,000$40,000
Post-retirement lifespan5 years20 years
Total post-retirement expenses$155,000$800,000


The bottom line of the table is that the need for savings has grown tremendously in the past fifty years. However, because of Social Security and Medicare, many people feel insulated from this dramatic increase in the need for savings.

For Discussion. What policies would encourage thrift?


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CATEGORIES: Social Security



TRACKBACKS (5 to date)
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The author at Right Side of the Rainbow in a related article titled Is America on its way to looking like Europe? writes:
    Economist Arnold Kling is wondering how we can get people to save more for their retirement, which now lasts longer and costs more than it did 50 years ago. If they don't, America will start to look like Europe: ...... [Tracked on October 5, 2004 6:22 PM]
The author at BusinessPundit in a related article titled Carnival of the Capitalists - Anniversary Edition (pt 1) writes:
    Welcome to the 53rd edition of the Carnival of the Capitalists! Today we celebrate the beginning of our second year. The Cotc was a product... [Tracked on October 11, 2004 5:42 AM]
The author at BusinessPundit in a related article titled Carnival of the Capitalists - Anniversary Edition (pt 1) writes:
    Welcome to the 53rd edition of the Carnival of the Capitalists! Today we celebrate the beginning of our second year. The Cotc was a product... [Tracked on October 11, 2004 5:49 AM]
The author at BusinessPundit in a related article titled Carnival of the Capitalists - Anniversary Edition (pt 1) writes:
    Welcome to the 53rd edition of the Carnival of the Capitalists! Today we celebrate the beginning of our second year. The Cotc was a product... [Tracked on October 11, 2004 7:58 AM]
The author at BusinessPundit in a related article titled Carnival of the Capitalists - Anniversary Edition (pt 1) writes:
    Welcome to the 53rd edition of the Carnival of the Capitalists! Today we celebrate the beginning of our second year. The Cotc was a product... [Tracked on October 11, 2004 6:36 PM]
COMMENTS (18 to date)
Mcwop writes:

More accomodative regulations that allow companies to automatically enroll employees (if they want out they must opt out) in a company sponsored retirement plan. More campanies are doeing this (though still the minority), but the regulatory maze is a nightmare to the point that it varies for each individual state.

The benefit is overcoming non-participant inertia, and participants can always opt out. Once in the plan most people are happy, especially once the balance starts to accumulate. This is not a panacea, but a nice place to start.

spencer writes:

if you look at the past 25 year record the policies most likely to lead to an increase in savings would be policies that cause the stock market and home prices to fall.

For a quarter of a century we have implemented many different tax code changes designed to
induce increased savings. But during this period the savings rate has fallen massively.

So the question is why have these policies failed. the answer is that the increase in wealth from stocks and home ownership has been so great that people did not need to save.

Thus, to get more saving make stock and home prices fall and the fall in consumer wealth will lead to more savings.

I know economists will say this is stupid. But this is what the data tells us and I challenge anyone to disprove my argument.

KipEsquire writes:

And let's not forget the basic national income account constraint that, in equilibrium, savings must equal investment. People can't save, even if they want to, unless there are investment opportunities for their savings to flow into. So our policies (taxation, regulation, etc.) toward business and entrepreneurship must also be considered and structured toward the most pro-investment stance possible, even if our "real" priority is to foster increased savings by individuals.

Don Lloyd writes:

The most important thing to do is to eliminate the long term grinding force of monetary supply inflation.

Saving is entirely irrational for the vast majority of people who have little or none of the special investment expertise needed to maintain or increase the future purchasing power of their savings against perpetual monetary supply inflation. This cannot be solved in a one-size-fits-all investment strategy as only a contrarian accumulation of specific exchange-valued assets can be effective.

In mass, no free lunch exists, and the accumulation of money and other exchange-valued assets can only determine the distribution of future consumption, not its overall level. Only additions to the supply of resources, both human and material, and increased productivity in their employment can be effective in augmenting the future overall level of consumption.

Regards, Don

Joshua Allen writes:

Spencer, the flaw in your argument is that you assume that investing in the stock market and "saving" are necessarily different. Especially in the context of this discussion, "saving for medical expenses for retirement", it should be assumed that the personal savings would be parked in some moderately liquid investment vehicle. Kip got it right.

Don, I think it's smart to control inflation, and it's true that inflation discourages people from stashing dollar bills under their matresses. But I think it's overly simplistic to assume that normal people cannot accumulate purchasing power under inflationary conditions.

In any case, I think the real problem is, as Arnold say, "many people feel insulated from this dramatic increase in the need for savings." If people had to make the choices for themselves and see the direct impact on their retirement, they would put more downward pressure on prices, put more emphasis on prevention, and so on. In fact, the vast bulk of expense to the medical system today, in coronary disease and type II diabetes, is caused by people making bad personal decisions over a long period of time. As long as it's covered by insurance, people allow conditions to develop which are much more expensive to treat in the long run than to address with personal decisions earlier on.

On the other hand, the nature of medicine is that there will always be upward pressure on prices. Life is something for which there is a very inelastic and insatiable demand. People will pay just about anything to get an extra year of life, and so any new procedure, however expensive, will be in demand so long as there are people near death who have money.

Bruce Bartlett writes:

People don't necessarily need to save more, they just need to work longer. The idea of quitting all work at age 65 is simply passe. If people worked until at least 70, it would solve a lot of problems.

rvman writes:

The expenses are also further out in the future for a 45 yo now - the 10k in health costs are more likely 1k per year, with a big hit right toward the end. With modern investment vehicles like mutual funds, returns compared with the 1950 era savings accounts or savings bonds are much better. Between those two things, savings rates needed are much lower than what Arnold suggests. If savings vehicles are sufficiently better today than before, then the modern 45 yo, looking at an age 70 retirement (or a post-retirement career, also common) may be looking at needing less in PV terms than his ancestor.

Tom Kaminski writes:

What precisely constitutes "saving" for economists? It's not clear to me from the things people have already posted on this topic. Here's a concrete example. Each month I put some money in a retirement fund (TIAA-CREF). I have a choice of either bonds (TIAA) or stocks (CREF). I put all my contributions into stocks because I expect them to have a greater increase in value over time. Is that saving? Would it be any different if I put the money into the bond side? I think of this money as an "investment," the purchase of an asset that I expect to appreciate in value; but it seems different from the economic concept of investment as money spent to increase the amount of productive capital. So, am I saving or not? And what's the difference?

Tom Kaminski

Mcwop writes:

A lot of "complex" explanations about why people don't save. However, the explanation is much more simple. People that do not save simply don't get around to doing it. I know this from personal experience as someone who works with large defined contribution retirment plan participants that do not save - even when generous plan matches exist.

Here is some work by Thaler and Benartzi that will shed some light.

spencer writes:

Tom you question of about what is savings is on target. In economics savings is the difference between current consumption and current income is savings.

Tom, in your example savings is the sum that is taken out of your pay every month and added to the fund. The value of the fund is an asset, not savings.

If your goal, for esample is to have a $1 million dollar protfolio at retirement it is easy to calculate the monthly savings you need to achieve that goal under an assumption of averge stock returns. But, if over time actual stock returns differ from the average assumed you will need to change the monthly additions to the fund to achieve you goal. Since from 1980 to 2000 stocks and returns from housing exceeded the original estimate an individual could cut the monthly savings needed to achieve the goal. So a bull market leads to lower savings.

Josh -- it does not matter what the savings will be used for. Conceptionally, purchasing a long term health care insurance policy is the same as purchasing a whole-life insurance policy or an annunity.

Rick Stewart writes:

Arnold's question was 'what policies would encourage thrift.'

I suggest eliminating (or privatizing, as long as you get rid of the pay-as-you-go aspect) social security would be a good start. Then phasing out medicare, or at least changing it to welfare healthcare instead of healthcare for everybody.

As stupid as it is, many people will believe the government if it tells them it will take care of them from cradle to grave. At the same time, the vast majority of people will figure out how to take care of themselves if they believe no one else will do it for them.

When the government stops promising to save our money for us, we will save more money ourselves.

Tom Kaminski writes:

Let me throw out a problem that I have with the idea of forced savings and how I think it might play out if Social Security was at least in part privatized.

Let's say that each person is required to put 2 percent of his salary into some sort of investments (a stock or bond fund). This will result in an immense amount of new money chasing a limited amount of available assets. That is, the number of stocks is limited, as is the quantity of bonds in circulation. The enormous new inflow of money can be expected to bid up prices of these assets, but the underlying value of the assets will remain largely unchanged. As a result of the new forced savings, I would expect a rapid rise in the value of stocks over several years (which will excite all investors and encourage more workers to put even more money into retirement stock portfolios), followed by a huge correction destroying much of this wealth. I am not a market pessimist; it just seems to me that if stocks and bonds represent real assets, they will not be able to increase in value at the rates required of them by this new scenario. This view is in keeping (I think) with one of Arnold's earlier pieces on Social Security, "Privatization, the Ultimate Lock Box." There Arnold argues against the idea that the stock market can continue to increase in value by 7 percent per year when the economy expands at a lower rate. His arguments there seem to offer a mathematical basis for my own gut instincts about asset inflation.

dave meleney writes:

Of the 800g's it looks like we might need for retirement, how much do most of us expect to get from gov programs (does Gallup have numbers?) and what's our scientific wild guess about what they'll actually pay? Then I start to get a grip on where this is may be headed.

Dave Schuler writes:

Something that everyone appears to be ignoring is that what is saved is not spent on consumption. What do you think would be the effect on the economy if there were a sudden increase in savings to, say, 8% of income?

Like it or not we have an economy that is driven primarily by domestic consumer spending. A sudden reduction in that could have pretty serious consequences. And not just here. The whole world depends on U. S. consumer spending.

Boonton writes:
Let's say that each person is required to put 2 percent of his salary into some sort of investments (a stock or bond fund). This will result in an immense amount of new money chasing a limited amount of available assets. That is, the number of stocks is limited, as is the quantity of bonds in circulation.

Stocks and Bonds are in limited supplies? Hardly, it takes maybe $200 to create a corporation and issue stock and a bit more to sell shares as penny stock. Likewise companies can issue bonds as much as they please (restrained by the willingness of investors to buy them).

Imagine the market wants to consume and not save. A 'forced savings' plan would result in 'savings' puchasing stocks and bonds and the proceeds used to fund consumption. For example, imagine a bank selling $100B in bonds to people forced to satisfy a '2% forced savings law' and then issuing credit cards with limits totalling $100B. The savings is nothing more than consumption!

Sam writes:

Anyone here checked out "The Coming Generation Storm: What You Need to Know about America's economic future"? I'm not an economist(trying to learn the basics), but Laurence Kotlikoff argues that the aging population will lead to a deep depression as the population ages and Social Security/Medicaid/Medicare are stretched thin.

As for the answer to the question, I think we should privatize and eventually cut down all those programs. Let the people get the benefits they've already put into Social Security, but stop putting money into it. Limit Medicare and Medicaid.

I'm almost for letting people just sink or swim. We can't spend all our money supporting old folks, as our technologies allow us to keep them "alive" for just a few years longer... few years longer... few years longer. They need to provide for their own retirement. We can give them the bare mininium to survive, but we can't keep putting off old age for free.

Bill Fellers writes:

It seems to me that people don't save that much because of Social Security--people already think they are saving.

Mark Horn writes:
Something that everyone appears to be ignoring is that what is saved is not spent on consumption. What do you think would be the effect on the economy if there were a sudden increase in savings to, say, 8% of income?

First, let me assure you that I'm not an economist. I just read (and enjoy) this site. That being said, here's what I think would happen. The first thing that would happen, before we started saving 8% of our income is that we'd pay down our high interest rate credit cards. This would have some impact on how credit gets used. What that impact is I don't know, but I would speculate that there would be fewer "rewards" associated with the use of credit cards - because there would be significantly fewer people paying high interest, credit card companies couldn't fund a lot of those rewards. Additionally, I think the number of institutions offering credit cards would substantially drop.

What would happen after that is that the increased number of people putting money into the bank would cause added pressure on the banks to encourage lending. This combined with the lower use of credit cards would result in more lending for things like homes or business expansion. The jobs that had previously existed in credit card companies will be transferred into home building companies, or into the businesses that take out loans to expand.

So I think two primary things:

  • Decreased use of tax disadvantaged credit (e.g. credit cards)
  • Increased use of tax advantaged credit (e.g. mortgages and business loans).

  • Ok. Now all of the economists can critique me. I look forward to constructive feedback.

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