Sunday, 19 February 2012

Savings Myths

This general set of related topics was suggested by Chef Dave in a comment to my recent post on why the Multiplier Effect is a load of nonsense. We know that politicians love waffling on about "encourage people to save" or bemoaning a "low savings ratio" and so on in order to justify all manner of counter-productive policies, but what on earth does this mean in practice..?

1. First of all you have to decide for yourself what "savings" really are, or what the point of doing it is, and whether "savings" is not an aim in itself but merely the result of "people and businesses behaving rationally", in which case, there is no need for a government to do anything to "encourage saving" and it is quite sufficient to simply get rid of all the policies which discourage people and businesses from acting rationally.

2. Secondly, you have to decide how to measure "savings" or "the savings ratio" and if it cannot be done, then it would be impossibly to judge the success or failure of any policies designed to "encourage savings" in the first place. As far as I can see, the most important thing is looking at the actual substance of savings, wealth and investments in general, which i will lump together as SWIG for sake of a better word.

3. True SWIG is the actual productive capacity of the whole economy, taking public and private sector, businesses, households and individuals together. If businesses become more profitable, if output, employment and wages go up, then this is an increase in SWIG. We can argue the merits of the constituent parts, what is better - higher employment at lower wage rates or lower employment at higher wage rates? What is better - higher business profits or higher wages? But this level of detail is best left to market forces and are difficult to measure anyway - for example, does the income of a self-employed person count as 'profits' or 'wages'?

4. A fair measure of the total productive capacity are 'macro' things like GDP, or GNP if you want to subtract net imports. Of course these include 'made up figures' but as long as they are prepared consistently then an increase is good and a fall is bad. Employment and total wages can also be measured reasonably accurately, but quite what the level of unemployment is depends largely on how you define unemployment.

5. GDP and suchlike measures merely measure the flow or creation of wealth over a month or a year, and not the stock of SWIG at a fixed point in time. Is there any reliable way of measuring the actual stock of SWIG at any one point in time? To my mind, it is nigh impossible, or requires so many judgment calls as to be meaningless:

a. Total market capitalisation of companies, i.e. the market value of shares in issue and outstanding debt is unreliable, because share prices fluctuate a lot for reasons other than underlying profits, for example if profits go down by a tenth but interest rates fall by a fifth, then share and bond prices might still go up.

b. Land values (above and beyond bricks and mortar) are irrelevant, as they merely represent capitalised value of the future transfers of wealth from productive economy to land-owners, so for every £ in the selling price of land, there is a latent liability on everybody else to pay £1 in future. One man's gain by 'investing in land' may make sense on an individual level is less than the other man's loss on a macro-level. The value of bricks and mortar is not that reliable either. Although replacement cost can be measured, there are plenty of houses built which end up being worth less than what they cost to build, as happens when a land price bubble bursts (see ghost estates in Ireland, Spain, USA) or if you build a new house in an area prone to flooding or subsidence.

c. Cash in the bank is unreliable, it merely represents a claim on the bank's total assets, so we have to look through to how the bank has lent that money (or how the bank lent money to give rise to the deposits), which in turn gives the bank part-ownership of the assets of the borrower. If it was lending to productive businesses, then it would be sufficient to look at the income and assets of the borrowing businesses, if it is lending on (inflated) land values then this is not real wealth at all.

d. Money invested in government bonds or the future value of a public sector worker's pension is offset by an equal and opposite liability on the taxpayer, so that's meaningless, and because the recipient applies a higher discount rate to the likely receipt (uncertainty) than the payer applies to the liability (prudence), we actually end up with a net negative.

e. It is meaningless just to look at the assets of private sector businesses without looking at the corresponding assets of households. So if a hotel has TV sets in all of its rooms, or a launderette has washing machines, or a delivery company owns cars, those are worth no more or less than the TVs, washing machines and cars owned by private households. And how do you measure the value, even if you could count them all up? Replacement cost, value in use, depreciated cost, selling value? All these measures give quite different values.

6. Then we have the point that there is a fixed amount of SWIG (even though we have no real idea what it is worth in £'s at any one point in time), albeit hopefully growing at 3% or 4% a year, and that growth is simply down to businesses becoming more efficient or specialised as we get clever and cleverer in what we do. So that growth will happen anyway, who ends up owning it is a secondary issue.

7. On an individual level, of course any individual can be a net cash saver or a net cash borrower. It would be quite possible for every individual to have a small positive level of cash savings if the other side of the equation is a loan by the bank to a productive businesses (see 5c. above). This equation is self-correcting as regards productive investment - if everybody wants to save, then interest rates go down so more businesses can start up, or interest rates are so low that fewer people want to save.

If people's total cash in the bank is above and beyond that level required to fund true SWIG, then the chances are that the excess has merely gone into inflated land values or inflated share prices. Unfortunately, these bubbles become self-sustaining for a while, because people think that capital gains alone will pay off the interest, which is impossible in the long run (see 5 b.), and this all reduces total SWIG.

8. Further, the ideal savings ratio for any individual over his or her lifetime is precisely zero, by all means, borrow to finance your education or buy a house; then pay off those debts as fast as you can; then build up a surplus for a rainy day or retirement, but from a certain age, you maximise your own utility by spending it all again, because you can't take it with you. Unless it gives you greater happiness in your old age to give money to your children and grandchildren, which is an emotional thing, not an economic thing.
Having established all that, let's have a detailed look at some of the savings theories and counter-productive policies doing the rounds:

8. The Austrian Theory of The Business Cycle "emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not."

There is no need for anybody to make a conscious decision to "save" to kick start anything. Underlying all this SWIG is the rational impulse of an entrepreneur to make more profits in future than he does today. Sometimes this involves spending money he has saved up, or working unpaid for himself, or persuading others to work for the business for low wages in exchange for getting a share in the business. Even if the entrepreneur borrows money from the bank, this is just a long-winded way for people who work for other employers reducing their disposable income in exchange for a share of profits in his business. (The same logic applies to studying or apprenticeships - lower wages or even running up debts for a few years in exchange for much higher wages in future. Employees are just entrepreneurs with only one customer - their employer.)

I would heartily agree with them that credit-induced booms are not sustainable, but they have a blind spot when it comes to describing the flip side of the credit induced boom - inflated land prices, and the obvious way of preventing those booms - shifting taxes from incomes to land values is anathema to them.

9. The Paradox of Thrift: "The narrow claim transparently contradicts this assumption [that what is true of the parts must be true of the whole], and the broad one does so by implication, because while individual thrift is generally averred to be good for the economy, the paradox of thrift holds that collective thrift may be bad for the economy.

Yes, it would be true that if all private households tried to spend as little as possible, the economy would soon collapse to a mere subsistence level. To some extent this effect explains recessions - when people are worried for the future, they spend less, so some businesses go out of business, then people get more worried etc in a vicious circle.

Further, it's easy to imagine that private households save by leaving cash in the bank (which is not really saving, on a macro level) but what about businesses? For them, real saving is reinvesting profits in greater capacity, so goods and services get cheaper until all but the parsimonious can no longer resist buying stuff, and under the 'paradox of thrift', business wouldn't be investing at all they would be running down plant and machinery, shedding staff and hoarding cash - does this count as saving or as dis-saving?

Finally, this paradox is never going to happen in practice, we are in the worst recession/depression since the 1930s but in most countries, GDP is only down five or ten percent (the same as in the 1930s). So any suggested solutions to the 'paradox' is tilting at windmills, we might as well devote the whole of our economy to dealing with the possible effects of the impact of a massive meteor (or climate change or something equally unlikely).

10. Some take this faintly silly argument to a dangerous conclusion: "Keynesians [who know little of what Keynes actually said, he was far more nuanced that this] argue that a liquidity trap means fiscal policy becomes very important for getting an economy out of a recession... The argument is that the rise in private sector saving needs to be offset by a rise in public borrowing. Thus government intervention can make use of the rise in private saving and inject spending into the economy. This government spending increases aggregate demand and leads to higher economic growth."

That site gives the monetarist counter argument to that. To my mind it's nonsense anyway.

a. There are things which only the government can do (such as overriding the interests of NIMBYs and other vested interests), some of these things are always worth doing, some are never worth doing. Some of these projects might not make sense when labour costs are high but might make sense during a recession when labour costs are lower, and contractors are willing to accept lower prices, but that's just common sense.

b. Doesn't this trample all over the freedom of the individual to save? What's the point in saving if the government is running up debts on your behalf - in the current context, by taking wealth from cash savers and transferring it to borrowers (land speculators and banks), which reduces SWIG.

c. Further, people worry a lot about large government deficits, so even if the government could find stuff worth spending money on (and they can't, we are way past that point), this extra worry might make people save even harder, thus exacerbating things under the Paradox of Thrift - see 9.

11. Then we have politicians wailing on about the savings ratio, a high savings ratio is seen as A Good Thing, this is more bunkum

a. The politicians have contradicted themselves completely by first wailing on about the Paradox of Thrift and using it to justify deficit spending and then trying to encourage saving at the same time. Even more bizarrely, they justify deficits by saying that it makes it easier for the private sector to save (do they want them to do so or not?) if the public sector is running up debts, it's perfectly circular non-logic.

b. The charts in Tutor2U (1980 - 1999, see previous link) and the chart here (1987 to 2009) show that the savings ratio is merely the mirror image of credit/land price bubbles. So if you want people to save (in the sense of genuine savings i.e. genuine increases in SWIG), the best thing is to prevent credit/land price bubbles (see 5b.).

c. Those charts mainly show the level of cash savings, which are in themselves an unreliable measure of real savings, i.e. real increases in SWIG (see 5c.). If you want to measure real SWIG, there are far better ways of going about it (i.e. to look at real GNP, or GDP minus net imports).

12. Then we have politicians wailing that people should be "encouraged to save", which all sounds very motherhood-and-apple-pie but leads to more nonsensical policies.

a. Some people will save anyway, some people (and i am one) will always try to restrict their spending to less than what they earn for fear that one day they will earn less. Some people will never save, regardless of the incentives. There is a small minority who wouldn't bother saving but for the incentives. These incentives are hugely expensive and incredibly badly targeted (they only affect the behaviour of the small minority and incentives paid to those who would have saved anyway are a waste of money). Finally, who pays for these incentives? Not the savers, but the non-savers. So this means that non-savers have even less money left over which they could save; and the small minority who "save" might not be net savers at all, they might just underpay their mortgage to take advantage of the incentives.

b. Tax arbitrage wipes out most of the gains to savers. Interest earned on cash in an Individual Savings Account is exempt from tax. Well big deal, all that happens is that banks offer lower interest rates on ISA accounts. The same larceny applies on a grand scale with pension funds. By and large, the return which a basic rate taxpayer gets by chipping post-tax income of £x into stocks and shares every month, or into a cheap tracker fund, will give him the same net-of-tax income in retirement (but with a lot more flexibility) as chipping in £x to an official pension fund.

c. There's a limited pool of SWIG for people to invest in. The total dividends paid out by UK plc's last year was £65 billion. The main asset of UK pension funds is shares, so the main source of income for pensions is dividends. There are 12 million people of pension age in the UK, so even if they'd all diligently saved into private pensions, then for every pensioner who gets a private pension of more than £5,400 a year, there's somebody who's getting less. These glossy adverts by private pensions companies which suggest that we can all have a super-comfy lifestyle in retirement are clearly bunk. For every couple who does, another couples can't, it's that simple. It's as insane as the Home-Owner-Ist idea that we can all be landlords and live off rental income, or that buying land is "investing".

13. Successive UK governments simply can't make up their tiny minds whether they want to encourage or discourage pension saving. As Iain Duncan Smith (the current welfare & pensions minister) points out in that second article, spending more taxpayers' money on a means-tested type of old age pension (Pensions Credit) actively discourages lower income people from saving up, because every £1 extra private pension (or investment income) they get means £1 less taxpayer-funded pension. So a good place to start is to have a non-means tested Citizen's Pension and leave people to their own devices if they want more than that.

14. Finally, we have the myth that rising house prices are a kind of saving or investment and should be treated as favourably as cash savings. They are not a kind of saving at all, they are merely a measure of how much wealth is being transferred from one group to another (see 5b.), best case, they purely paper capital gains and not real wealth at all. The interests of cash savers (to the extent that cash on deposit represents real savings on a macro-level, even if they are savings at individual or micro-level) and land-owners, particularly the highly leveraged speculators, which includes a lot of owner-occupiers are diametrically opposed and current government policies (low interest rates and corresponding high inflation) clearly favour the interests of those sitting on paper gains and are a kick in the teeth for those who have always lived within their means and put some money away.
Right, that's enough to be getting on with, time for a coffee and cigarette in the back garden before the sun goes down.


Anonymous said...

Stop taxing me and I would save more,or spend more, simples

Mark Wadsworth said...

Anon, yes, I made that point several times in the post. if we tax rental value of land, not incomes, then that has the added bonus of not needing any of these myriad income tax breaks for "saving".

Old BE said...

Does this all come under what I call "you can't plan to win"?

Society spends (IMHO) far too much effort trying to find a formula that works. I suspect there isn't one. Some decisions work out because other people bet the same way and others work because other people bet the other way, and vice versa.

I have come to the conclusion that no individual can reliably decide what the best financial strategy is.

For example, Mr A might have a HUGE pile of savings in various ISAs and cash accounts. Tomorrow QE goes wrong and all Mr A's "wealth" is wiped out.

Ms B puts a vast proportion of her income into a sanctioned pension fund and has therefore paid a very low rate of tax for her whole career but is hit by a bus three weeks before retirement.


Anonymous said...

Ok, so we want to have a LVT/CI, tweaked to provide a higher CI for older people, right? So a pensioner get 50% or maybe even 100% more than people of working age. The abolition of current taxes would increase land values by x amount (150%?), and this will increase baseline living cost even if prices for everything else will continue to go down as productivity increases. Workers get wages + a CI, and that means that this effect will be compensated. Pensioners get a slightly higher CI, but is it enough?
So what if we want pensioners to have more income (for whatever reason)? Does your demonstration of the futility of private saving for increasing pensioner incomes (as a whole), mean that the only way to achieve that, is to stagger the rise in land values with income taxation for the purpose of financing additional pensions on a pay-as-you-go basis?


Mark Wadsworth said...

BE, individuals can plan to win, we started with the first man who worked out that hunting with a spear produced more meat/effort than just chasing after them, and we've been honing that ever since. The best thing the govt can do is leave well alone.

Kj, the point is that all pensions are ultimately pay-as-you-go. if pensioners get all the dividend income, that's because other people are a) working and b) not getting any dividends. And if pensioners are getting all the dividends because they own all the shares - what is there left for savers to invest in??

In terms of govt provision or safety net, pay-as-you-go out of current taxes is the cheapest in admin terms and least risky for individuals (no investment fluctuations to worry about).

So old age pensions can be funded out of LVT the same as anything, if we give more to pensioners, there's a bit less for everybody else, that's a purely political decision (I'd give pensioners double the CI for working age adults, for example).

By the way - I'd assume that for LVT purposes, pensioners' main residences would be exempt for the time being (I woudn't have the nerve to bring it in on Day One). The alternative is to tax pensioners' homes at full rates but to dish out this extra tax as much higher old age pension, so instead of young people paying for old people, it's old people in big houses paying for old people in small houses, and average pensioners in average houses would be entirely unaffected.

Kj said...

that's because other people are a) working and b) not getting any dividends. And if pensioners are getting all the dividends because they own all the shares - what is there left for savers to invest in??

And another question posed is whether the big heavy institutional investors make for actors in the capital market one would want at all, especially if most pensions are forcibly converted to funded pensions. Already finding investments for the oil-fund that can get the dreamy returns that the budget calls for is proving difficult.

...we give more to pensioners, there's a bit less for everybody else, that's a purely political decision (I'd give pensioners double the CI for working age adults, for example).

I was thinking about this, and one aspect is that a smaller CI for the rest as a result of redistributing within CI funds for the benefit of older people makes for a smaller safety-net for those not getting wage income and not being of pension-age, and they would be better off if the pension was funded out of current wage-income instead of LVT. Ofcourse this evens out as low-wage earners would also earn less as some is siphoned off as NI-payments, and as you say, that's a political question.

Mark Wadsworth said...

Kj, those are what I would call "political questions", everybody can make up his own mind.

Lola said...

I am not at all sure that all Autsrians are anti LVT. I am one and I am not.

Lola said...

I think the nub of all that stuff is that 'central planning doesn't work'. The very fact of trying to measure all these things - GDP, Savings ratios etc etc gives the measurers the false idea that they actually know what's going on and, most distressingly, know how to 'make it better'.

The Austrians merely observe the results of the 'acting man'. They don't say what he does is good or bad, it just is, but they also observe the magic of the 'invisible hand', and they do recognise the need for law and order and the guarantee of property rights.

Otherwise all spot on IMHO.

Mark Wadsworth said...

L: "The very fact of trying to measure all these things - GDP, Savings ratios etc etc gives the measurers the false idea that they actually know what's going on"

IMHO, the only thing worth measuring is GDP and everything else follows. The great Georgist Cowperthwaite, who took over the running of Hong Kong decided not even to bother measuring GDP, he just set up a crude LVT system and let them get on with it, with predictably awesome results.

Lola said...

MW - Yep, I was going to reference Cowperthwaite and Hong Kong. GDP can still be distorted, so best not trust it too much.

Lola said...

For fun went to Wikipedias Cowperthwaite entry.

One para reads as follows:

"Commentators have credited his management of the Hong Kong economy as a leading example of how small government encourage growth.[2] However his starting of a large public housing programme which made the Hong Kong Government the world’s biggest landlord and the setting up of the Hong Kong Jockey Club as the region's monopoly in gambling business are rarely mentioned.[2][3]"

Hah! I do not see any conflict all with public housing (entirely compatible with LVT) and nationalised gambling seems to me to capture something similar. Anyway trying to stop the Chinese from gambling is like try to stop the Sun from rising.

Mark Wadsworth said...

L, Cowperthwaite is one of those mystical figures who never, ever said anything in public. Macarthur was positively verbose in comparison.

My interpretation is the same as yours (and whoever wrote that Wiki biog) but the Faux Lib's only ever look at the "low regulation, low income tax" side of the equation (which is important, don't get me wrong, but only half the story).

Lola said...

Something else - Cowperthwaite did not 'manage the economy' at all - that's the point, he just got out of the way of 'human action'.

Anonymous said...

"The main asset of UK pension funds is shares, so the main source of income for pensions is dividends."

The capital is a source of pensions too. In fact, I suspect it is a more important source. Of course, somebody has to buy the shares to release that capital. That could be someone else who hasn't retired paying into the scheme, or it could be somebody else entirely if the scheme sells the shares. In other words, all pension schemes have an element of "pay as you go", kind of!

Mark Wadsworth said...

L, correct, if in doubt, do nothing.

AC, agreed. The maths is trickier than what I said in the post - it is twenty million pension savers buying up the shares and reinvesting the dividends, when they retire, they sell the shares and buy bonds instead to get annuity. But however cleverly you do the workings, it is mathematically impossible for everybody to have a funded, private pension of more than £6,000 or so.

As long as some people don't bother saving, then others can indeed have private pensions of £10,000 or £20,000. But if everybody saved every last penny, share prices would go through the roof, interest-annuity rates would plummet and we'd still have the situation that total pensions paid out will be nor more than an average of £6,000 per pensioner, absolute maximum.

Bayard said...

" it is twenty million pension savers buying up the shares and reinvesting the dividends, when they retire, they sell the shares and buy bonds instead to get annuity. But however cleverly you do the workings, it is mathematically impossible for everybody to have a funded, private pension of more than £6,000 or so."

Can't they just buy bonds in the first place? There's an inexhaustable supply of those, although Greek ones might not be such a good idea.

Mark Wadsworth said...

B, you can mix and match as much as you like, you still end up with a figure of about £6,000 per pensioner, assuming ALL UK quoted shares and bonds/gilts are owned by people saving up for a pension or by annuity providers.

Bayard said...

Surely not if you include foreign bonds as well, or are those already included in the calculation?

Mark Wadsworth said...

B, ignore foreign bonds, it's still a zero-sum game taking all pension savers and all pensioners internationally.