Bold Move Needed to Boost Saving
The American economy is suffering from a tremendous imbalance between our national saving and domestic investment. This imbalance causes us to import massive amounts of foreign capital, about $144 billion last year. While these inflows of foreign capital help in the short run by keeping interest rates down and by financing our domestic investment, in the long run they will put substantial pressure on our economy. The only way to relieve this pressure is to restore the balance between national saving and investment. This will require larger and swifter reductions of the federal deficit than are in prospect.
National saving is the sum of what households, businesses and our federal, state and local governments set aside out of their income (rather than spending it). From 1950 to 1980, net national saving in the United States--after subtracting depreciation of capital assets--averaged about 7.5% of gross national product. During this period, net private saving was very close to net national saving, as the government sector more or less followed Polonius’ advice to “neither a borrower nor a lender be.”
By the late 1970s, however, the federal government started to run fairly large deficits, which were partly offset by state and local government surpluses. On the other side, net private domestic investment--the sum of what we invest in business plant and equipment, residential construction and accumulation of inventory--was also a little over 7% of GNP. In this 30-year period, the United States was on average a slight net exporter of capital to the rest of the world.
The 1980s are radically different in saving and investment patterns. The roughly 7% rates of the 1950-80 period look good by comparison, even though they were the lowest net saving and investment rates of any advanced economy. The net national saving rate in the United States has fluctuated from a low of under 2% to about 5% in the 1980s. In 1986--the fourth year of a business cycle expansion--our net national saving rate was a paltry 2% of GNP. This is simply abysmal. Business saving from retained earnings was close to long-run historical levels. Personal saving had fallen off about 1 percentage point of GNP. The state and local government sector was running abnormally large surpluses of about 1.4% of GNP (although much of this was in their pension funds).
However, the federal government ran a deficit of almost 5% of GNP. Of the total private saving available, 5.4% of GNP, the federal government borrowed more than 80%. The only ways to increase our net national saving rate are to reduce the federal budget deficit sharply or to increase private saving substantially. It would be very difficult to increase private saving by several percentage points of GNP quickly. While we need to work on the private saving front, the only way to get our national saving rate up anytime soon is to reduce the budget deficit.
Things are somewhat better on the investment side of the equation. Private domestic investment was about 5.5% of GNP in 1986, not a very good performance, but imagine what would have happened if the investment had been constrained by national saving to a paltry 2% of GNP. That would have been a disaster. The difference, in the short run, was that we imported foreign capital. Nobody believes that the way to get our saving and investment rates back in balance is to reduce an already dangerously low investment rate. We desperately need that new investment to increase the productivity of our workers in order to compete internationally without a drastic fall in wages paid to American workers.
What is especially novel about the past year or two is that more of our net investment has been financed by foreigners than by Americans. There is no convincing example in economic history of a wealthy society continuing to grow at reasonable rates by borrowing from abroad to finance investment. The success stories of growth financed by foreign capital have all been of less developed countries--whether those of today or economies such as the United States and Canada in the 19th Century (for example, we financed much of the construction of our railroads by borrowing from Great Britain).
There are no major problems with large net flows of foreign capital into the United States for a short period of time, but now that we have become a net debtor nation, continuing flows of foreign capital of almost $150 billion a year set up a compelling dynamic that has escaped sufficient public discussion and political debate. Eventually, we will have to export more than we import by enough to pay the interest and dividends that foreigners earn from assets in the United States.
Take, for example, the $144 billion of excess investment by foreigners in the United States over what we invested abroad in 1986 (before 1980, the largest amount of capital that the United States had ever imported was only $10 billion). Suppose, for simplicity, that a typical rate of return on this investment is 10%. That means that over $14 billion, net, every year will be earned by foreigners just on the U.S. investments they made in 1986. Every year of large foreign capital inflows adds to the amount by which our exports must exceed our imports.
We are currently running a trade deficit of $148 billion. The decline in the dollar should reduce this some in 1987, but no one is expecting it to plummet close to balance quickly. Thus, each year that we are accruing these obligations to pay foreigners such large amounts of interest and dividends means that the pendulum must swing back not only from large net imports to trade balance but actually further than that, all the way to becoming a large net exporter. The same type of rapid shift in the economic fortunes of specific regions and industries that accompanied the shift in our trade balance in the past few years must occur in the opposite direction, perhaps as soon as the 1990s. That will place severe pressure on our economic and political system.
There is a potentially insidious time bomb in the growth of what Americans owe to foreigners. A temptation that has often proved irresistible in such situations is rapid inflation. That is because a sharp, unanticipated increase in the inflation rate will decrease the purchasing power of that foreign debt. In short, we will pay it back in cheaper dollars. This is a different situation from the pressure to inflate when the federal government of the United States has a large and growing national debt owed to Americans.
Unexpected inflation transfers wealth between creditors and debtors. If the inflation rate accelerates unexpectedly, debtors gain and creditors lose because the debts are paid back in dollars that have been devalued by inflation. In previous episodes in the United States, that implied a redistribution of wealth among Americans from those who are lenders (usually thought of as the wealthy and the elderly) to those who are borrowers (usually thought of as poorer and younger persons). But the larger the external debt becomes, the more the redistribution would be from foreigners to Americans, and hence the greater the temptation to inflate.
We badly need to raise our net national saving rate, both to reduce the insidious cumulative pressure to reinflate--which would lead to another round of political and economic disruption and to a sharp slowdown in economic activity to curtail the inflation--and to provide the domestic resources to finance a reasonable level of investment. This will reduce the need to import foreign capital, provide future elderly Americans with greater assets with which to finance their own retirement and prevent our investment rate from plummeting still further.
While it would be desirable to increase the private incentive to save, it is increasingly essential to reduce federal borrowing, for that is the only way to raise our net national saving rate quickly and substantially. That implies a tax increase or much tougher budget control than Congress has been able to muster. As we approach the 1988 presidential election, it is difficult to see the political process making major headway on either. It would take a tremendous bipartisan compromise to achieve much reduction. More likely--and sadly--we will wait until 1989 or beyond to deal seriously with the problem.
