Is There A Savings Paradox?

April 08, 2009

This morning's news from AON, the insurance broker, that it is cutting company contributions to its employees' defined contribution pension schemes means, according to the Financial Times, that workers will need to save three times more to keep the company payment at existing levels. That type of increase seems a highly unlikely outcome, given the current squeeze on take-home incomes. But if employees don't add more to their pension schemes, they face the prospect of greatly reduced pensions post-retirement.

Add to that the big chunk of most people's pension pots taken out during the last 18 months by the equity bear market, and the fact that it now takes more and more cash to convert into the same fixed level of income once you get to retirement (in the UK, annuity rates are plummeting with the fall in government bond yields), and you can see why people are under pressure to save more and more.

But, as Keynes famously pointed out in the 1930s, if everyone starts saving during a recession, then aggregate demand in the economy will fall and the recession will become worse. My Wikipedia search this morning alerted to me to the fact that the "paradox of thrift" can be seen as a form of the "prisoner's dilemma" in game theory, where "if the members of a group trust each other, they can choose a course of action that will bring them the best possible outcome for the group as a whole. But without trust each individual will aim for his or her best personal outcome - which can lead to the worst possible outcome for all."

This comparison appears to reflect the consensus view in most Western economics faculties and among government advisers. For the Keynesians, and for those governments around the world that are currently borrowing like crazy to stimulate their economies, those increasing their savings should be seen as indulging in a selfish and disreputable activity - often called an "antisocial refusal to spend".

Further east - from France and Germany in the EU, to the current account surplus countries in Asia - this view is regarded as nonsense. The philosophical divide was papered over at last week's G20 meeting in London, but it's clearly there. While the Keynesians, Brown and Obama, call for ever-larger stimulus packages, the Czech PM, in a rare display of pre-summit candour, stated that the US-UK policy was the "way to hell".

The contrast between the two camps is shown most clearly in the respective governments' approach to gold.  While the ultra-Keynesian Brown ditched half the UK's gold reserves at an average price of US$ 275 between 1999 and 2002, many current account surplus countries' governments are quietly accumulating it. The Russians are steady buyers, and while Chinese reserve policy is still dominated by holdings of US government debt, there are plenty of reasons to think they are following suit.

There's an old maxim about the golden rule - "he who has the gold makes the rules". Perhaps that's why the US government has been reluctant, despite the rhetoric, to ditch its own bullion. If I had to bet on the ultimate outcome in the philosophical battle between the spending countries and the saving countries I know which side I'd pick as winners. While government policy in many Western countries is predicated on continuing to spend, there is no reason why individuals shouldn't ignore Gordon Brown's advice and take a more "eastern" approach to managing their money, saving more.

So is there a paradox of thrift, and is it selfish not to want to want to bankrupt oneself for the greater good? I don't think so.


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