Tuesday, May 29, 2012

Saving for a Rainy Day


Larry – eat your vegetables, read a book, and save some of your allowance.  How many times did my mother advise me of the basics of a good life? It is not easy to argue with any of these recommendations. We wouldn’t need this kind of advice, of course, if it was easy to follow. Most people struggle to find time in the day to read and learn; to prepare healthy meals; and to not spend every penny. It is this spending and saving issue I want to focus on in this post. The bottom line is that the US squandered decades of opportunities to prepare for an economic crisis like the one we have been experiencing. It didn’t have to happen this way and it was caused largely because we cannot control our national spending.

Wants have no bounds. We can want more goods and then when we have enough of them we often want better ones. In either case this satisfaction requires more income. Not all of our money is spent on our own material satisfaction as most of us share our incomes with our relatives, friends, and members of our community. There is no real end to what we could spend in any given month or year. Yet, we all know that we should save. We save for predictable future events like our kids’ college educations. Of course we all know that Social Security is not enough to provide for our needs in retirement so we save for our golden years. We save for unpredictable events so that we can weather unexpected disasters, an illness, or a job separation.

If we don’t save then we take risks. Every month that finds us spending as much or more than our incomes means that we incur risks. This is not ALWAYS bad. If your future income is higher than expected you and your children can borrow money  at that time to finance a college education. Or you might be lucky and never encounter an unexpected layoff or firing.  Your employer might offer you a great retirement package that supplements your Social Security payments. You might win the lottery or receive a major gift from a relative or friend.  In those cases it turns out that you probably could have saved less. But then again, many of us may not be so lucky and therefore it is very important that we save. If we do not save and if we are not so lucky, then we suffer unnecessary consequences. Our child may not be able to afford college. A lack of saving means that you might have to sell your car or house after you lose your job. It could also mean that you have to borrow money or move into the home of an unpleasant relative. 

You get the picture. Another way of saying this is that there is a clear TRADEOFF between spending today and spending tomorrow. It is tempting to not save today. There is so much we need.  There is so much good we can do with the money right now. But this preference for the here and now clearly and definitely has a cost in terms of the risk of severe difficulties in the future.  By saving a little bit each month you reduce these risks. You sleep a little sounder and there is less probability of an economic disaster in the future. This is what my mom meant.

We are all human and therefore it is easy to understand human failings. But we should, I think, have a higher standard for countries and governments. While we could debate forever the appropriate extent of government spending and saving, I think most of us agree that there should be a government and we should pay taxes to that government so that it can perform important services.  A government is just like a person or household in the sense that it receives income (tax revenues) and it spends (outlays).  And just like us, a government can spend more or less than its current income. When it spends more than its income we call that a government budget deficit or government dis-saving. When it spends less than it receives we call that a government budget surplus or government saving.

Most of us expect our government to be prudent. Some countries have VERY prudent governments that routinely save.  Singapore is one of those countries. The Singapore Investment Corporation takes the country’s saving and invests it on the behalf of the people of Singapore.  We do not all share the view that governments should always save. To many of us, a prudent government would be one that saves in some years, dis-saves in other years, and routinely has some balance between deficits and surpluses. Notice that if a country follows this flip-flopping saving pattern that it never acquires much of a national debt. In years of deficits countries must borrow and acquire debt. In years of surpluses they do the opposite. Debts rise in some years and then are paid off in future years.  This behavior is sensible for me and you and most of us believe this is good for our government as well.

This means that we understand that countries, like individuals and families, have “bad years” where they need to spend more. We even have things called “automatic stabilizers” that enforce that outcome. When a country grows slowly, spending automatically rises and tax revenues fall without any legislation. Of course, when a country enters a very bad economic period, the government will sometimes augment these automatic stabilizers with discretionary fiscal policies that are designed to generate even bigger deficits. While the latter is controversial, I think it is safe to conclude that most people think this is government business as usual. 
Many of us believe it is the right and the responsibility for the government to spend more than it receives in revenue during slow growth and recessionary periods.

Luckily for most countries recessions are infrequent. So while we encounter deficits in the recession years, we have plenty of years to offset the debts incurred. Between 1990 and 2010 there were a total of 21 years in the US. Of those 21 years we had recessions that spanned about four years. After the recession in 1990 we did not have another recession in the USA until 20001. The next one came at the end of 2007. That means there were roughly 17 years when we did not have a recession. It is not unthinkable that during those 17 years our government would have been saving for a rainy day. How might things have been different during the global economic recession of the past years had government’s taken Marge Davidson’s advice to save a little?

Saving is made easier during years where economic growth is stronger. Automatic stabilizers raise tax revenue as they reduce government spending. So the automatic tendency is to increase government saving during these non-recession y ears. During all the non-recession years between 1960 and 2010, you find exactly that – tax revenues not only rose but they rose as a percentage of GDP. That is, taxes rose even faster than GDP in each between-recession time period. But here is the interesting thing about the USA – in only one of these time periods between recessions did the USA budget balance turn to surplus. Between 1991 and 2000 the USA government budget went from a deficit of 3.6% of GDP to a surplus of 1.9%. But even in this case lasting 10 years only three of those years showed budget surpluses. Thus the entire between-recession decade had a very large deficit and managed to add about 18% to the USA national debt.

The recovery and expansion after the 1960 recession lasted about seven years. The first five years had surpluses followed by two years of deficits before the recession of 1969/70. That was the last between-recession time period which cannot be characterized by rising national debt. In that one case, government debt neither increased nor decreased. In a half century of US history we therefore find that our government has not been prudent.  We have added greatly to our national debt during recessions and added even more to the debt during the best times.

You might say that there were between recession time periods when the deficits were made smaller and I would agree with you. The data shows that the US budget deficit fell between 1976 and 1979, 1983 and 1989, and between 2002 and 2007. But notice that in these three episodes the lowest yearly government deficit as a percent of GDP was respectively, 0.5%, 2.4%, and 1.7%. In one sense that is good news. 

During those between-recession years, government deficits as a percentage of GDP did decline. But please notice that during each of those time periods, the national debt rose respectively by 7%, 26.3%, and 14.4%. It is not enough to reduce the deficits in those strong growth years – a country needs to provide surpluses to pay down their debts. Otherwise the debts get larger and larger.

Last month I spent $4 of my $2 allowance. Mom, I only spent $3 of my $2 allowance this month.  It is true that I did better this month and while my debt per month got smaller – my total debt increased from $2 to $3. This is no way for little Larry to get ready for college and it clearly is no way to run a country.  With more saving and less borrowing the onset of the world financial crisis might have been less impactful. More importantly, with more saving and less borrowing, the ability of countries to positively deal with the impacts of the crisis would have been much stronger. Clearly one lesson we should learn from this crisis is the importance of sovereign saving. Of course, we might also eat more vegetables and read a book or two!

I end this with a comparison of the US against 29 other countries – countries that are compared in a publication called Annual International Economic Trends published by the Federal Reserve Bank of St. Louis. Using a recent edition and an earlier one dated 1999 I was able to cobble together annual government budget balances (as a percent of GDP) for 30 countries from 1986 to 2007 – a time period encompassing 22 years. 

I rank these 30 countries in terms of how many times they saved – or how many times* they had budget surpluses in those 22 years. A brief summary follows:
·         Out of those 30 countries, the US ranked 19th in number of budget surpluses.
·         The US had four surpluses in those 22 years. Those surpluses came back-to-back between 1996 and 1999. During those 22 years there were four recession years. The US government should have been able to save in 18 of those years and managed to save in only four of them.  In 14 years of growth taxes as a percent of GDP rose. Thus in the US we found ways to increase spending even more than taxes during the good times.
·         5 Countries were the best savers with S. Korea and France leading that group having surpluses in all 22 years. The other three countries Malaysia, Chile, and Norway had at least 19 surpluses in the 22 years.
·         Another 13 countries were middle savers – with government surpluses in 5-14 of the 22 years.
·         The bottom group of government savers consisted of the remaining 12 countries – countries that had surpluses in 0 to 4 of the 22 years. Five of these 13 had deficits in all 22 years (Austria, Greece, Israel, Italy and Turkey. The US was part of this group.

*I admit that this evidence is not exhaustive. I have not accounted for the size of the surpluses and deficits. But my main point has to do with spending habits and habits have something to do with frequency.  The US government saved only 4 times in 22 years while most countries routinely saved much more frequently. Since the median number of years saved by these 30 countries was 8 years – the US was well below the median. 

The US is in the company of several countries that have had the most dire choices and consequences because of their inabilities to withstand the financial impacts of the recent world economic recession. 

5 comments:

  1. I, however, place economy among the first and most important republican virtues, and public debt as the greatest of the dangers to be feared. - Thomas Jefferson

    ReplyDelete
  2. http://townhall.com/columnists/walterewilliams/2012/05/30/our_nations_future

    Lets hear it for Dr. Williams! Pay particular attention to the last statement in the article.

    ReplyDelete
  3. I was lucky enough to meet him back in the 1970s. Walter Williams is quite a guy!

    ReplyDelete
  4. Rainy days always make us cry. As he walked across the floor surrounded by death with the battle raging just outside of the castle....swaet dripping down his face with a the tstench of fear in his eyes.. What are we gong to do? What are we going to do.

    We cannot save but we can kick hard decision cans downthe orad. We can print money and spin excuses that are beleivable by our under educated public. But we cannnot stup the the tipping point of which we have arrived.

    Spending: When the country was int he last wo bubbles, the consumer was spending way beyond their means and so was the governments (what's new) After all it was a bubble. Now consumers have for the most part pulled back from that behavior and are actually saving but there is nothing to invest in other than Asia and commodidities. Government has spent $2 to $5 trillion (depends on whose facts are accurate) on savings itself withthe hope that some would trickle down and stimulate the private sector whcih employs about the same people a s the government.

    The fast growing job category during this recession was and remains grant writing. Go figure! Where did those trillions go? whaere is the accountability that a private corporation would have to have for it's shareholders?

    The US was a great nation but itis stimbling now for a wide range of reasons. We have discussed many of them on this blog.

    ReplyDelete
  5. Yup James. The story is simple. If you don't put away a penny for the future then in the future you do not have a penny. I wonder why our government thinks that is okay and us people let them do it.

    ReplyDelete