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For Release on Delivery
10:00 a.m., E.D.T.
May 16, 1991
Testimony by
Alan Greenspan
Chairman, Board of Governors of the Federal Reserve System
before the
Committee on Finance
U.S. Senate
May 16, 1991
Mr
Chairman, I appreciate the invitation to appear before this
committee today.
As you know, I have long been concerned about the low
level of saving in the United States and am pleased that this important
problem is drawing renewed attention.
In my prepared statement, I will
address some of the broader issues bearing on saving and investment, as
well as provide a review of the available evidence on tax incentives for
personal saving.
Put simply, inadequate domestic saving is impairing our
economic prospects for the longer run
I say this with full recognition
that the appropriate level of saving for any economy is best left to
private preferences, as reflected in the marketplace.
However, as a
society, we have in recent decades clearly intervened in the market
process through subsidies that enhance consumption at the expense of
saving
And, we would be well-advised to endeavor to redress such
imbalances
Saving, of course, arises when part of the nation's current
production is diverted from consumption, both private and public; it
provides the funds for capital formation.
Thus, by choosing to consume
more now—and to save less—we are limiting our ability to expand and
upgrade our stock of capital.
It is the size of that stock and the new
technologies embedded within it that, together with the quality of the
labor force, ultimately determine our overall productive capacity and
the future standard of living of our population.
The damage from low saving does not show up immediately
It is
more insidious—it chips away at the productivity gains we are able to
achieve over time, it gradually hampers our competitiveness in
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international markets; and, after a period of years, it results in a
lower standard of living than we would otherwise enjoy.
Of course, U.S. investment can be funded by foreigners, as well
as by domestic residents.
Indeed, since the mid-1980s, sizable inflows
of capital from abroad have helped to sustain domestic investment and,
thus, have cushioned the effect of inadequate domestic saving on worker
productivity.
But heavy reliance on foreign saving is neither a
satisfactory nor a sustainable solution over the longer run.
This may
seem contrary to the idea that international capital markets are wellintegrated and that competing rates of return will draw funds to the
most productive uses anywhere in the world.
To be sure, in today's
world, such inflows may tend to be sustained longer than in the past
Nevertheless, the evidence for the United States and for most other
industrial nations over the past hundred years indicates that large
inflows have not persisted and, thus, cannot be viewed as a reliable
substitute for domestic saving on a long-term basis
In other words,
domestic investment, for the most part, appears to follow domestic
saving in the long run.
Reflecting the large current account deficits of recent years,
foreigners are accumulating claims on a sizable portion of our future
output.
Furthermore, we know that we will have to support a rapidly
growing population of retirees two or three decades in the future.
In
the end, our ability to meet those commitments, while providing rising
living standards to future workers, will depend on the investments that
we make in capital and in new technologies in the interim.
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Indeed, on the basis of our recent saving behavior, it is
difficult to see how we were able to achieve the high standard of living
that we now enjoy.
saving society.
The answer is that we have not always been a low-
Granted, the statistics are problematic, but it appears
that in the period following the Civil War, when the United States began
to emerge as an economic power, our saving and investment rates, as
conventionally measured, were much higher than those in Europe and
Japan.
For example, between 1870 and 1910, domestic saving in the
United States averaged close to 20 percent of GNP. The best available
estimates for Japan and Germany during that period place their saving
rates at 15 percent or less.
The saving rate in Great Britain, whose
preeminence was fading, was closer to 10 percent.
The shift toward both a relatively low and an absolutely low
saving rate began during the Great Depression, when the U.S. rate fell
dramatically.
In the decades after World War II, it stabilized at a
level slightly below its pre-Depression average.
Notably, between 1950
and 1979, domestic saving averaged about 16 percent of GNP—roughly the
same as total investment.
Budget deficits generally were small, at
least by today's standards, and the private saving rate showed no
discernible trend
Meanwhile, the U.S. enjoyed a positive—and
gradually increasing—net foreign investment position.
In the 1980s,
the pattern changed markedly, as domestic saving fell well below
investment, reflecting not only the enormous federal deficits, but also
a large drop in the private saving rate
In recent years, U.S. saving
{public and private) has totaled only about 13 percent of GNP.
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Saving rates in Japan and Germany also have declined some over
the past two decades, following their surge in the post World War II
recovery period, but they remain substantially above those in the United
States
Relative to their GNPs, the Japanese have been saving roughly
twice as much in gross terms as we have, while Germany's saving rate has
been about 1-1/2 times ours.
Cross-country comparisons of net saving
should be viewed with some caution because of differences in how
depreciation is measured; nonetheless, the gap in net saving probably is
even larger than in the gross measures
The high saving rates in Japan
and Germany have been mirrored in rapid rates of capital formation that
have helped them improve their competitiveness relative to the United
States and close much of the gap in living standards.
The issue of why one nation saves a lot while another saves
relatively little—or why saving behavior changes over time—is complex.
It undoubtedly reflects cultural influences as well as economic forces.
I suspect, however, that part of the explanation relates to how well
members of a society, both individually and collectively, assess their
future needs and take action in the present to meet them.
Collectively,
we have recognized the need to build saving and capital, and to improve
our productivity performance, in anticipation of the significant
increase in the ratio of retirees to workers next century.
However, as
last year's debate over the financing of social security made clear, we
have yet to take sufficient actions to meet these needs.
As you are
well aware, the surpluses in the social security trusts have been
overwhelmed by enormous deficits elsewhere in the federal budget.
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Just as the budget deficit accounted for a large part of the
fall in domestic saving in the 1980s, the surest way to raise saving in
the 1990s is to get the deficit down
Last fall, you enacted a
significant program of spending and tax changes and budget process
reforms.
Those actions set the underlying or "structural" deficit on a
downward track and thus represented a strategy that is geared to the
longer-run needs of the economy.
I recognize that, in the near term,
those savings are being swamped by the transitory effects of the weak
economy.
But, as the recovery takes hold, the federal sector's
absorption of private saving should return to a downward trend.
The goal of a balanced budget is a good place to start
But,
as I have said frequently in the past, it probably is not ambitious
enough as a target for the longer run. As long as the non-socialsecurity deficit remains sizable, we are doing little to ensure that
adequate provisions are being made for the income of future retirees
Further actions must be taken to bring the rest of the budget into
balance, so that the trust funds will no longer be financing current
government consumption, but will translate dollar for dollar into
national saving.
The federal budget deficit is only part of the story of the
past decade.
Saving by households and businesses also has dropped. The
fall in personal saving, in particular, has been studied extensively; in
large part, it appears to be associated with the sizable increases in
household wealth through the latter part of the 1980s. To understand
the relation between wealth and the saving rate, it is important to note
that personal income, as defined in the national income and product
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accounts (NIPA), measures the income from current production; it does
not include the effects of capital gains or losses on assets already
held by households; personal saving also ignores revaluations of
existing assets. Thus, an increase in the value of an individual's
stock portfolio or his house has no direct effect on his measured
income.
But, if he raises his spending in response to the capital gain,
NIPA saving will fall.
Looking at the data, one sees clearly that the surge in the
stock market between 1982 and 1987 was associated with increased
consumption out of financial capital gains and, therefore, with reduced
saving out of current income.
In addition, the build-up of readily
accessible home equity enabled many individuals to spend more out of
current incomes than they would have otherwise—especially with home
equity lines of credit making it much simpler to borrow against the
value of one's house
The data for Great Britain in the late 1980s
support a similar linkage between surging real estate prices and falling
rates of saving set aside out of personal income; more recently, the
British saving rate has turned up as house sales have cooled.
Analyses of the relation between saving and demographics in the
1980s also have attracted much attention; on the whole, however, the
results of these studies—as well as the implications for the 1990s—are
less clear-cut than one would have expected.
Nonetheless, with older
members of the so-called "baby boom" generation moving into their
forties, the issue of retirement saving is coming to the forefront.
One way to engender more national saving, of course, is to
reduce the federal budget deficit.
But, we can also take actions that
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should encourage individuals to save more.
proposals for new saving incentives.
There is no shortage of
Some would function in a manner
similar to that of the individual retirement accounts (IRAs) of the
early and mid-1980s, which allowed workers to make deductible
contributions and to defer the tax on both the principal and earnings
until the accounts were cashed in.
Other suggested incentives, such as
the Family Savings Accounts favored by the Administration, would not
allow deductible contributions up front, but would permit earnings to
accumulate tax-free as long as the account balances were maintained for
a specified amount of time.
The plan offered by Senators Bentsen and
Roth (S. 612) incorporates both approaches.
When considering these proposals, a fundamental question that
must be addressed is how they are likely to affect total national
saving.
It is relatively easy to imagine an incentive that will raise
personal saving.
But unless the increase is large enough to outweigh
any associated drop in tax revenues—or sufficient deficit-reducing
actions are taken elsewhere—the net effect on national saving will be
negative.
In other words, the sum of private consumption plus public
consumption as a percent of income must fall for the national saving
rate to rise.
I recognize that, under the current budget procedures, any
anticipated loss of revenue to the Treasury from a new tax-favored
saving plan will have to be offset by increases in other taxes or by
reductions in mandatory spending.
This requirement should blunt much of
the concern about potential drains on national saving—at least over the
next five years.
But, as a matter of sensible tax policy, any new
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incentive must first be evaluated on its own merits and in isolation
from other considerations.
Essentially two types of evidence bear on that assessment. The
first is the broad economic evidence on the relation between saving and
the rate of return on saving, which has been studied intensively over
the years
In theory, the higher after-tax rate of return produced by
an IRA or other incentive has two effects. On the one hand, it
increases the amount of future consumption that each dollar of current
saving will buy, thereby providing an Incentive to save more now in
order to consume more later. On the other hand/ because each dollar of
existing saving generates more after-tax income, the individual can
reduce current saving and still enjoy more consumption both now and in
the future.
In principle, either effect could dominate, leaving the
question to empirical resolution
Unfortunately, economists have not
been able to develop unambiguous evidence on this score.
The second type of evidence for evaluating a new tax incentive
comes from the microeconomic studies of the 1982-86 IRA experience.
Clearly, IRAs were very popular, with contributions averaging nearly
$35 billion per year; this amount was equivalent to roughly one-quarter
of personal saving as measured in the national and product accounts.
However, at the time, many analysts believed that little, if any, of the
money flowing into the accounts represented new saving—a perception
that undoubtedly contributed to the scaling back of IRAs as part of tax
reform in 1986.
It is important to remember that in order to have
increased saving, an IRA would need to have reduced consumption,
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Since then, many new data have become available, and several
studies of the IRA experience have been carried out. These studies
provide a wealth of information, but, again, the results are
inconclusive.
Some essentially confirm the "conventional wisdom" that
IRAs involved primarily a shifting of saving from one pile to another,
without much effect on the total. But others suggest that IRAs provided
a substantial boost to overall saving and that their effectiveness would
have grown over time as people exhausted their opportunities to shuffle
existing assets.
The lack of conclusive evidence on saving incentives makes it
difficult to take a strong position either way on the desirability of a
new IRA.
In addition, that determination depends on how you plan to
meet the pay-as-you-go requirements in the new budget procedures; the
necessary cuts in spending or increases in other taxea may, in turn,
have incentive effects of their own
In any event, the overall
desirability of the package cannot be assessed until you specify and
evaluate the offsetting elements.
In conclusion, it is important to continue to focus on the
crucial need to restore saving in the United States to levels that are
consistent with our longer-run economic objectives
As I noted earlier,
the time is particularly opportune for exploring ways to facilitate
retirement saving, given the large increase in the number of retirees
that will occur within the next few decades. There may well be a role
for a well-designed private saving incentive in that process
But, the
historical evidence suggests that devising such an instrument will be a
difficult task.
In the end, substantial reductions in the federal
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budget deficit are still the surest way to overcome the shortage of
domestic saving and, thus, to increase permanently the supply of
domestic funds available for investment.
@FedFRASER