TCS Daily

Saving Freedom

By Arnold Kling - October 5, 2004 12:00 AM

"Noneconomists imagine that God has so poorly designed the world that a lack of thrift, even tending to avarice, is, alas, necessary to keep the wheels of commerce turning, to 'create jobs' or 'keep the money circulating.' They imagine that people must buy, buy, buy, or else capitalism will collapse and all of us will be impoverished...

Nothing would befall the market economy in the long run, says the modern economist, if we tempered our desires to a thrifty style of life -- one old Volvo and a little house with a vegetable garden and a moderate amount of tofu and jug wine from the co-op.
-- Deirdre McCloskey

Economists are increasingly coming to appreciate the need to fight common prejudices against saving. Because of what Nobel Laureate Robert Fogel calls technophysio evolution, the alternative to a high rate of personal saving is heavy dependence on government as people age and require health care.

Retirement and Health Care

What Fogel means by technophysio evolution is the ability of the human species to lengthen its lifespan. This has dramatic effects on the need for saving.

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 Driver

50 years ago


Average annual health cost



Other annual expenses



Total annual expenses



Post-retirement lifespan

5 years

20 years

Total post-retirement expenses



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. In reality, Social Security and Medicare are already in deficit, and the situation will worsen dramatically going forward.

We can either fund our increased post-retirement spending needs individually, out of personal savings, or collectively, out of taxes on the incomes of those who create income and wealth. In the absence of reform to Social Security and Medicare, we will choose the route of higher taxes, with potentially disastrous consequences for economic growth and personal freedom.

Forced Savings

Even left-leaning economists appreciate the need to reform Social Security. Recently, Brad DeLong endorsed privatization of Social Security, using arguments reminiscent of those that I employed in The Ultimate Lockbox and in several chapters in my book. DeLong wrote,

"Too many households are myopic: they do not save enough. Households resist increases in Social Security taxes--they see no link between the taxes and their future benefits. But if Social Security were privatized so that households saw their Social Security contributions as their own, in the future there would be much less objection to upping the contribution rate--and so creating a real and more effective forced saving program to raise the national savings rate.

"...privatization is a necessary first step to create the possibility of doing the moral thing--making the boomers build up the assets needed so that they can shoulder a greater share of the burden of financing their own retirement.

"We need to raise our national savings rate. But if we just raise Social Security taxes, Congress will treat these taxes as general revenue and spend them."

DeLong is saying that today's 45-year old needs to put away much more money for retirement than is accounted for by today's Social Security taxes. However, raising Social Security taxes is not the solution, because Congress will spend the money rather than save it. Instead, DeLong favors privatizing Social Security, and presumably requiring higher contribution rates once these private accounts are established.

DeLong sees privatizing Social Security as a way of forcing today's workers to undertake the large increase in savings demanded by technophysio evolution. Ironically, at least one libertarian-leaning economist, Tyler Cowen, was repelled by this rationale for privatization. He wrote,

"I would like to see social security evolve into a system of welfare for the elderly, and junk the forced savings aspect. Keep in mind those "private" accounts will be regulated rather than truly private in the libertarian sense. They will channel benefits to government-approved providers, thus leading to bureaucracy, regulation, and costly commissions. And if anyone's account goes bust, do you really think there will be no secondary safety net to bail them out? What if the whole market went bust for about ten years' time?"

I cannot share Cowen's position. My concern is that too many Americans believe that they are entitled to have someone else pay for their retirement and health care. If they are not forced to save during their working years, then they will spend everything, and then these spendthrifts will come whining to government to rescue them during retirement. Those of us who do save will then become soft targets for soak-the-rich political demagoguery, and our taxes will be raised to pay for the sins of the profligate.

To appease a purely libertarian concern about forced savings, I would propose allowing an individual to opt out of any form of Social Security -- traditional or privatized -- by signing a waiver. The waiver would state that "I understand that I have no right to expect anyone else to pay for my health care expenses or other retirement expenses." People who sign such a waiver could be exempt from any forced saving program.

Anti-Saving Bias

The most important contribution that economists can make is to counter the anti-saving bias held by the public. It is conventional wisdom among politicians, journalists, and the general public that consumers must spend freely to "keep the economy moving." However, economists increasingly disagree, as Deirdre McCloskey pointed out.

Bryan Caplan, who has examined surveys which asked identical questions of economists and noneconomists, believes that there are four ways in which noneconomists demonstrate economic illiteracy. Caplan says that the noneconomist public demonstrates anti-foreign bias (a belief that the benefits of trade and markets stop at the border), anti-market bias (a belief that price increases occur because businessmen become greedy; I would argue that this relates to what social psychologists call the Fundamental Attribution Error); pessimistic bias (failing to recognize the Escalation of Income); and make-work bias (worrying that higher productivity means loss of employment).

The belief that consumer spending is expansionary for the economy and that saving is contractionary represents anti-saving bias, which may be just another form of make-work bias. The same faulty logic that sees productivity as threatening to employment also sees saving as threatening to employment.

As McCloskey points out, in the middle of the 20th century many economists succumbed to anti-saving bias. John Maynard Keynes saw the "hoarding instinct" leading to reduced demand and unemployment. His followers shared his concern that excessive saving could reduce output and employment.

This anti-saving bias was the basis for Social Security's design, in which contributions and benefits were decoupled. Interviewed by Randall Parker in Reflections on the Great Depression, Moses Abramowitz said,

"We wanted to increase incomes, and so demand for goods, and so employment, and so on around. And the structure of Social Security, the fact that benefits were divorced from previous contributions, was part and parcel of the business of supporting demand. We didn't want a Social Security system where everybody paid an employment tax and didn't get immediate benefits from it. We wanted something that paid immediate benefits. But we didn't want to increase saving..."

Punishing Thrift

Social Security has a built-in bias against saving. This was deliberate, based on a Keynesian distrust of thrift. Economists no longer believe that saving is contractionary. Government's largest program is designed to implement a theory that is decades out of date.

Other government policies that punish thrift reflect even older prejudices. Because we tax income rather than consumption, a worker who earns $50,000 a year and saves $10,000 will end up paying much more in taxes over her lifetime than a worker who earns $50,000 a year and spends all of it. The income tax reflects Marxist theories that saving is done by a capitalist "class" that exploits workers.

Aid for colleges and universities is based on "need," where need is measured in large part by the absence of savings. This also punishes thrift. An alternative approach would be to measure "need" based on the last five years of household earnings, taking household wealth out of the equation.

Saving and Freedom

Another consequence of technophysio evolution, as well as a more dynamic economy, is that it no longer makes sense for corporations to offer generous defined-benefit pensions and health care benefits - what the writer Daniel Gross calls "welfare capitalism." He wrote, "The more welfare capitalism declines, the more the federal government will have to fill the gap, and the more America will look like Europe."

What Gross is suggesting is that the United States is headed for a government-dominated economy. The loss of economic dynamism and personal freedom under such a scenario would be tragic.

The European scenario can be avoided if the American people can be persuaded to maintain financial independence through prudent saving. The more that people save for contingencies such as job transitions, retraining, college education, retirement, and health care, the lower will be the tax burden on the hard-working and the thrifty.

Economists are coming around to the view that people should not be encouraged to spend freely in order to "keep the economy strong." Instead, particularly because of longer lifespans and more spending on health care, increased personal savings are required both to strengthen our economy and to maintain a system of individual liberty.

The author's latest book is Learning Economics.


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