What is this savings problem?

So far we have discussed Kiwisaver and national savings in fairly loose terms. We know that (part of) the purpose of Kiwisaver was to increase national savings and that our interest in national savings stems from the fact that we want New Zealand to have more productive capital.

So before we can discuss the myriad of burning questions surrounding these issues – and more broadly surrounding New Zealand’s productivity (such as if Kiwisaver achieves the greater capital goal even if it theoretically doesn’t increase savings) we need to ask, what is the savings problem?

David Skilling from the New Zealand Institute has written widely about the “savings problem” New Zealand faces. In his view we can tell that New Zealand national savings levels are low as our current account deficit is so high, our business investment is so low, our foreign direct investment is stagnant, and domestic investment in the local stock market is limited. This sets the stage for the savings problem to be defined as follows:

National savings levels in New Zealand are too low

However, the existence of a current account deficit is not evidence that savings are “too low” – it is only evidence that domestic expenditure on consumption and investment is greater than domestic income! This view is in evidence in both wikipedia and recent work by NZIER and Capital Economics Ltd. As a result, as long as consumption and investment are determined by individuals with sufficient freedom to make choices and there are no externalities and sufficiently good information and institutions in the country it seems a bit silly to say that savings is “too low” – savings will be determined such that individuals are maximising their lifelong expected utiltiy!

Furthermore, as Trihn Le from NZIER says:

the saving-investment-growth issue relates to national saving rather than household saving. New Zealand’s national saving rate has been largely positive and shows no sign of deteriorating

Remember, the purpose of saving is deferred consumption – if we invest in something it is so we can consume from it later! When describing the savings level we want it is important to look at national savings – not private savings, as that defines the level of true savings in the economy.

As a result, when discussing savings and investment we are talking about the trade-off between consumption now and consumption in the future. If we want more stuff in the future, we will have to sacrifice some consumption now. Rather than having government legislate the timing of our consumption, wouldn’t it be fairer to let people decide for themselves.

But …

It is still possible that we can have problems with savings. Fundamentally they fall into two categories:

  1. Market failure causing a sub-optimal level of savings,
  2. Market failure causing a sub-optimal distribution of savings.

Starting with the level argument it is important to look at the possibility of poor institutions and externalities. If the institutions aren’t up to scratch, the wedge between the return on investment and the return on savings will be greater – leading to lower levels of investment.

The externalities argument is more difficult. If we know that there are positive spillovers from investment, then extra savings may increase the return from further investment, leading to a significant increase in investment intentions and demand for capital. If this is the case we will have multiple equilibrium and government policy may be able to move us to a pareto superior outcome.

Furthermore, if we think there is a negative externality from consumption (by consuming you make other people feel bad about their lives) a higher savings equilibrium would be preferable – although I am not a big fan of this argument! (Update: CPW mentions that his doesn’t make sense – as since savings is deferred consumption we have to face the externality anyway.  He is right.  However, we can still justify looking at this externality if the marginal social cost rises in consumption and we have consumption tilting, which requires that the rate of time preference is greater than the interest rate)

The suboptimal distribution of savings is a FAR more important issue. This stems from asymmetric information. Fundamentally, New Zealander’s seem to hold an underlying belief that investment in housing is the best type of investment. Now, buying a house is definitely an investment with a return (rent or imputed rent as well as capital gain through the opportunity cost of land and other scarcity issues) that appears relatively low risk and has fringe benefits (its hard to get kicked out of a house once you own it).

However, our focus on housing seems to be a bit extreme as noted by the RBNZ.

As a result, a savings problem in terms of the distribution of savings that households have undertaken may well exist in New Zealand – this raises the question, will Kiwisaver help solve this problem?

(Update:  Hone rightly mentions that time inconsistency is a problem that the government may want to solve when it comes to the savings decision – this is another reason why savings may differ from what is socially optimal).

4 replies
  1. Hone
    Hone says:

    You missed one possible justification for Govt determining the optimal level of savings.
    You say “savings will be determined such that individuals are maximising their lifelong expected utility”. There are swags of experiments/evidence in the behavioural economics field that suggest that most individuals make choices that are (amongst other things) time inconsistent and not consistent with maximising lifelong utility. As far as I can tell there aren’t any studies that support the discounted or expected utility theories as descriptions of how people actually act. That means it is not necessarily a good idea to appeal to those theories as supporting the idea that people should choose for themselves. It also means it is possible (in theory) for Government intervention to raise overall utility in society. That said, Governments make time inconsistent decisions too, so time inconsistency or failure of discounted utility theory is not a justification for Government intervention. In general it is hard to see how Government can accurately uncover the optimal level of savings in practice even if there is some theoretical justification for an intervention. I reckon if Government can’t uncover the optimal policy it should seek to maximise experienced utility and forget about taking a stab in the dark on our behalf.
    Even if Government can’t determine the optimal level of savings, it can help households that have “self control” problems (i.e. know that for themselves it is a good idea to save but they don’t do it anyway, rather like going to the gym) by providing access to commitment mechanisms and/or “educating” unsophisticated consumers about the usefulness and existence of commitment mechanisms (illiquid assets being a typical way of providing a commitment mechanism as many will recognise from the “forced saving” rationale used by some people when they buy a house). Does kiwisaver fulfill such a role? Maybe in part, but the subsidies chucked into the scheme have absolutely no justification as far as I can see and if the “problem” being addressed was commitment problems, then a policy where you couldn’t get your money out for a while after having requested its release, let’s say a year, would suffice. The whole “not until you are 65” (it is 65 isn’t it?) is just dumb – from an individual saving decisions point of view .

  2. fred
    fred says:

    Well it would be good if the government (and oppositions) articulated their vision when it comes to of the accumulation of capital by individuals (yes it is more than just about “saving”). Cullen’s kiwisaver is clearly a transfer of wealth from the less fortunate to the more fortunate and, as you say, may not actually increase savings at all. What would an optimal level of “saved wealth” look like? Would it be held by individuals, families or in trusts and would it be in real estate, shares, businesses, and how much would be local versus foreign. We simply don’t know what the government wants and that’s more than likely because they haven’t really thought about it. Cullen hasn’t really explained the thinking behind Kiwisaver, and if I was being cynical I would simply explain it as “fund manager capture”.

    This question is along the same lines that Bruce Sheppard running on his blog.

    If it is left to the market is it inevitably necessary at some stage for the state to bust up monopolies and family dynasties, we see small dairy farms being swallowed up by the large ones – where does that end? And the minute you try to bust them the wealth evaporates overseas.

    Here’s what I think it should look like and some of the pre-requisites. Treaty of Waitangi settlements provide examples (good and bad) of how to structure the ownership (of capital). I think that that the asset(s) should be alienable, you should be able to bet the farm (or eat it) and no matter how it is structured it should be about individual property rights (and responsibility). So a bit of a shift away from the current thinking.

    The aim should be that the average person owns property/assets, a significant amount. What’s the total capital of the country per capita, the average held by the individual should be close to the median (socialists all agree). Combine this with a Zero income tax and a significant consumption tax (GST). The implications: no unions, no WINZ, virtually no welfare, IRD a fraction of it’s current size, no MSD, no housing corp. A huge release of current deadweight in the economy. Is there enough to go around? If it’s not around $300,000 (because we carry so much debt) then my idea falters but just a little, it’s not fatal, because the objective is that “NZ inc” owns something like microsoft and we are talking about a 20+ year timeframe.

    The optimal amount of property owned by the individual should be about the size that allows the shareholders to take a keen interest in it whatever it is and not too large that it stops them taking an interest and influencing outcomes.

    It becomes mandatory that everyone has a lawyer, an accountant, and a trustee, if you can’t choose them, then the role of the state is to provide you one. There is minimal interaction with the state apart from this. The model for this already exists, it’s analagous to the way some people interface to the IRD via an accountant, the other two roles replace all other services provided by the state (well apart from health and education, and that’s delivered by a competitive services model). Trustees are JP’s or the like with extra responsibilities for between 20 to 50 people.

    How to get there? The government announces that in, say, 5 years time every person reaching the age of 28 will no longer be eligible for any benefit or welfare, on reaching this age the trustee is given something like $200,000 to $300,000 for that person (not in cash but in shares or property). The trustee would have a suite of rules to apply, depending on the skills and circumstances & training of the person, ranging from sorry you have to survive on the interest to yes it’s enough for a deposit on the farm/business, after you have paid off the student loan.

    Each year following this, everyone turning 28 is added to the scheme, the syetem can be means tested, if you happen to be a Todd or a Fletcher or a member of Ngai Tahu, then the arrangement in these cases is family provides most state tops it up. Anyway, thats the general idea, I’m sure others can flesh it out.

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  1. […] Ultimately, if savings are “too low”, as both the Standard and National might feel, it must be because of a market failure.  The ways this failure could exist are discussed in this post. […]

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