Tuesday, March 12, 2013

Atlantic column: Building the wealth of the poor and middle class



New column up at The Atlantic. The basic idea: We should try to make Americans' wealth distribution more equal. Excerpts:
The math of wealth is actually pretty simple: It all boils down to four things: 1. How much you start with, 2. How much income you make, 3. How much of your income you save, and 4. How good of a rate of return you get on your savings...
So one obvious thing we could do to make wealth more equal is - surprise! - redistribution...giving the poor and middle-class more income will boost the amount they are able to save, the percentage they are willing to save, and the return they get on those savings. Part of the reason America's wealth distribution is so unequal in the first place is that our income distribution is very unequal... 
[But] the most potent way to get more wealth to the poor and middle-class is to get these people to save more of their income, and to invest in assets with higher average rates of return... "Cheap" is an insult, but being cheap is how you get rich... 
 For years, behavioral economists such as Richard Thaler have been studying ways to "nudge" people to save more...This means that more financial education in public schools is a must. I'm not talking about teaching kids the Capital Asset Pricing Model. I mean what Bob Shiller calls "basic Suze Orman stuff." How to make a monthly budget. What "saving" and "borrowing" mean. How wealth builds over time. How to avoid borrowing lots of money at high interest rates (e.g. credit cards and payday loans). Etc. The new Consumer Financial Protection Bureau can help a lot with this too, by preventing companies from tricking poor people into taking out high-interest debt... 
In addition to "nudging" middle-class and poor Americans to save more, we can help them get a better return on their assets -- the second thing that has a huge effect on wealth in the long run. This means helping middle-class people invest in stocks without paying high fees. The first part of this is teaching middle-class people to avoid making frequent changes in their stock portfolios... 
The second way to get better returns is to avoid actively managed funds. Actively managed mutual funds charge high fees to purchase portfolios of stocks that, statistically, are no better than simply buying a low-cost "index" fund that tracks the overall level of the market. Pension plans like TIAA-CREF tend to charge even higher fees, meaning even worse returns. Financial education can teach middle-class people what a low-cost index fund is, and how to invest in one.
Read the whole thing here!

84 comments:

  1. Noah,

    I applaud your willingness to acknowledge that your 3rd and 4th items are more important than 1 and 2. The left needs that balance of hard medicine view to balance their typical preference for the softer (redistributive) kind.

    But how about other government policies that contribute to the lack of wealth creation and ultimate inequality. Both housing and student loans are examples. While lending money can help the disadvantaged "create" wealth, almost unlimited lending support can lead to worse outcomes. In a sense, government support has pushed the levels of activity beyond where the marginal borrower can expect to create wealth. As evidence, just look at the eroding credit performance of student loans even as we are coming out of recession. Clearly, the marginal student, while they may be able to get relatively good jobs, can not afford to service the debt they took on to get those jobs and, therefore, can't start their wealth creation.

    I appreciate its politically difficult to arrive at better solutions but clearly more outright aid, less loan support and a more exacting criteria for aid are needed for this to work.

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  2. Noah,

    "If America's middle-class and poor people learn to be more cheap, then in 30 years, we will see a very different distribution of wealth."

    I seriously doubt it.

    First of all, the fundamental problem - and you touch a bit on it - is the information asymmetry between savers and the financial industry. Your average investor is a babe in the woods in the hands of even a typical investment advisor, and no amount of education is going to help that person successful negotiate that relationship. No matter what you teach them, the industry will find *some* way to fleece them. NINJA mortgages, anyone? AAA RMBS backed by NINJA mortgages? If the regulators didn't see the trouble with that crap, how do expect to teach consumers to do better?

    The only viable solution is to create a framework that permits every investor to make an automatic contribution towards an extremely low cost balanced portfolio without *any* contact with the financial industry. The most ideal solution would be simply to back money itself by a broad pool of capital assets so all we would have to do is hold money. This would have the additional benefit of anchoring our money fixation to the portfolio that CAPM (*you* mentioned it) tells us that we should hold, rather than to some ridiculously short-sighted consumption basket.

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    1. Ahh, but if savers do it right, they won't be affected by information asymmetry...in fact their portfolios will outperform those of almost all rich people.

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    2. Bill Ellis10:07 PM

      OK... Are ya gonna tell us how to do it right ?
      Maybe you could write some consumer econ posts? Do enough of them and you might have a nice base for a high school curriculum .

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    3. Yes. Hold a diversified portfolio. Hold only low-cost, low-fee, passively managed funds. Trade (rebalance) only once a year. Done. You will out-earn most rich people.

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    4. Ahh, but they *wont* do it right, Noah, unless you make sure they don't come into contact with finance professionals. If they do, they'll get fleeced over and over no matter what you try and teach them. Did you know there were garbage subprime RMBS in CDO's stuffed into dynamically managed SIVs that issued AAA commercial paper that got put in money market funds. Are you gonna teach people how to analyze asset backed commercial paper? Did you know that "cheap" index funds lend stocks to related party repo desks and the crappy lending fees can cause a serious deterioration in fund returns that is nowhere to be found in public disclosures. If you let Wall Street near defenseless investors they are going to get screwed.

      What is the possible benefit of everybody wasting time trying to figure out how to construct an efficient, well balanced porfolio? Why can't we just run a public system?

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    5. Bill Ellis12:11 PM

      K has a good point.
      I remember when I was a young man, I felt it was my responsibility to learn how to invest. I buried myself in the WSJ, Barrons, Forbes and Business Week. For years I tried to understand how what they were saying was connected to what they claimed to offer.
      I learned a lot of interesting stuff but absolutely nothing coherent or useful as far as investment advice.... It has made me investment shy ever since.

      I guess you can't build an industry on people's deepest dreams and fears about their futures by selling them..."Hold a diversified portfolio. Hold only low-cost, low-fee, passively managed funds. Trade (rebalance) only once a year. Done. You will out-earn most rich people."

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    6. Yes. K has a great point. Which is why it's so frustrating when people get pissed at the behavioral finance people (e.g. yours truly) for daring to suggest that they have behavioral biases that make them bad investors...

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    7. Investing is a pain in the neck. I don't think we should aim at a society in which everyone has to be a shrewd investor to live a decent life. How about a society in which everyone who is healthy and capable of working just works for a fair, solid wage, and everyone who is either too young, too old or too sick to work is supported by the output generated by those who are working. Everyone pays society for the support they receive in youth and old age by doing their share to support the young and old when they are of working age.

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  3. How about induce poor and lower middle-class Americans to "save more" in a more broadly defined sense? Save more by investing in yours and your children's education, in better housing closer to work, school or fresh produce (etc.). Its tough to do those things when you're mired by decision fatigue, and the returns on your effort are weakened by uncertainty. University Prep, a charter school in Detroit, had a program where they paid for all their graduates to go to college one year, except that each child that went had to accept a $2500 subsidized loan. Then they have the incentives associated with "buying in" to the program, but aren't in so deep that the decision to go to college seems too risky. It induces savings without the requirement that families be well-off already.

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    1. There are good idea too!

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  4. Anonymous4:09 PM

    I think one of the problems is that it doesn't matter how well a low or middle-income American saves. When a shock comes (either personally, like a shock caused by medical costs, or collectively, like the recession of 2008), the savings get used up and the household usually ends up in debt. Being in debt usually causes one to make worse financial decisions (pay day loans or not being able to leave your home to move to an area with better employment prospects) than one would normally make. This compounds the problem. A situation like the 2008 recession hits both the savings (since a portion of it is in stocks), assets (like a house), and income (due to significant unemployment time, not being 'lucky' in the recession). This can easily destroy all of an individuals wealth.

    When low and middle-income individuals are likely to have such an event (not being lucky in a recession or large medical costs) every ~10 years, it destroys the possibility of an accumulation of any real wealth by these individuals. This mostly only happens to lower and middle-income individuals, high income individuals have better connections (more likely to be 'lucky') and usually have enough savings and other assets to be able to survive without engaging in wealth destroying activities like selling low.

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    1. I think this is right...saving behavior is negatively impacted by negative events like health crises...which is why I want universal health insurance so that this doesn't happen to people.

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    2. This comment has been removed by the author.

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    3. Accompanied by universal car insurance, flood insurance, fire insurance, other-natural-disaster insurance, kid-going-to-private-college-and-unexpectedly-flunking-out insurance, addiction insurance, property-value-loss insurance, underwater mortgage insurance, recession insurance? It's tough to account for all the potential shocks that can drain savings incredibly quickly relative to the time it took to accumulate them, even for the most frugal of middle- or low-wage earners.

      And of course creating a lock mechanism by which poorer people have no access to their wealth/stocks/etc for the sake of protecting saving behavior/future returns on investment would be completely insane in terms of basic rights to property, so this shock-loss norm seems inevitable.

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    4. Nah. Most bankruptcies are health-related.

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    5. So adequate health insurance is actually more important than debt avoidance and year-to-year savings, in terms of absolute prevention of bankruptcy and protection of wealth for low- and middle-income individuals...

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  5. Noah,

    You mention Thaler's work on nudging people towards higher savings rates, but his preferred program ('Save More Later', as I understand it) hinges on stable employment and increasing wages over time. This is all fine and good for the fortunate middle class and up but far less productive for poor people and members of the middle class who've seen their incomes decline in the past five years, and stagnate in real terms for decades. Opt-out, better defaults and education to avoid managed funds or transaction costs, and so on are great, unless your income is declining over time.

    Long term, these are sensible policy moves, but in the current context it seems shortsighted to discuss wealth inequality without mentioning long-term unemployment, replacement of manufacturing/clerical jobs with low-wage service sector employment, etc.

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  6. Noah,

    The key implicit premise to this argument seems to be that the poor save less than the rich, and make destructive long-term borrowing decisions, because they have some behavioral deficiency that can be rectified through education. But there is some recent research that tends to show that the main difference between the poor and others as far as borrowing behavior goes is that the poor are poor. The poor face scarcity, and respond to scarcity in the same way everybody else does: with intense focus on the most urgent provisioning tasks at hand and a neglect of other, more global tasks. The poor save, but they save for very specific purposes.

    http://theslab.uchicago.edu/anuj/wp-content/uploads/sci.pdf

    Also, while I assume you didn't choose it yourself, the photo at the head of this article makes the very offensive suggestion that lower income Americans are fat, greedy gluttons whose predicament is the fault of their untamed avaricious impulses. Lower income Americans often do have problems related to food. One of those is that the food they can afford to buy and have the time to cook is very unhealthy.

    Apart from these points, it seems to me that the macro issue of national savings is not best addressed by the individualistic path of attempting to modify the individual behavior of many millions of people - although that can be a component - but through the fiscal system and publicly directed investment.

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    1. How about this?

      https://www.dartmouth.edu/~jskinner/documents/DynanKEDotheRich.pdf

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    2. Always seemed plausible to me. I assume that if you make people richer, they will save more, and that there disposition to do so continues to increase at the margin. But I'm not so sure that means the best path to making the poor richer goes through savings.

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  7. Anonymous6:29 PM

    I was a CFP for 15 years and helped a variety of people get ahead financially, but for some people it was 2 steps forward and 3 steps back, over and over. Mr. Smith fails to address a key component of class difference — how the future is perceived. Upper classes expect the future to be good for them, so they can defer gratification, and they have the means to do so. Lower classes have anxiety about the future, partly because they are more likely to spend all of their paychecks on immediate needs and partly because they have less control over their financial lives. And so they tend to worry about the future when it arrives because the present is tough enough. Their ability to defer gratification is much different. That's a huge factor in investment returns. So Smith nibbles around the edges of managed funds vs index funds and ignores culture, perhaps the biggest factor. He also ignores predatory practices by institutions who take advantage of more ignorant consumers —payday lenders, rigged mortgages, unclear financial agreement language, regulatory failure, a Republican Congress that refuses to back Consumer Protection legislation.

    Mr. Smith needs to get out more, away from his ivory towers and upper-class neighbors and actually meet with poor people to see how they live and make choices. He can start by reading Orwell about the simple joys of sweets and cigarettes.

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  8. JK Rowling must have had a great savings rate when she was on the dole!

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    1. We should institute a program to make every poor person a worldwide bestselling author...

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  9. Anonymous6:58 PM

    Sorry to have to say this, Noah, but this is one of the DUMBEST things I've ever read. And that's giving you the benefit of the doubt, or I'd tell you it's cruelly self-righteous.

    You do what the word "poor" means, don't you?

    You might just as well have insisted that poor people all enroll in the grad econ program at the University of Michigan. Get PhDs in economics, every single one of them. They'd all get in, of course. And they could all afford it. What with all that money they have that they're gonna learn how to save once they get there.

    NOT.

    Come on, Noah.

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    1. Anonymous9:47 PM

      I can't speak to the prospects for a holder of a PHD in economics but I good friend recently got his PHD in History. He's now teaching a few classes as an adjunct and doing some free lance journalism. At the age of 35 this will be the first year he earns over $30,000. Student debt? Of course.He may be smart and he may be a hard worker but he comes from a background of limited means.

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    2. Sorry to have to say this, Noah, but this is one of the DUMBEST things I've ever read. And that's giving you the benefit of the doubt, or I'd tell you it's cruelly self-righteous.

      Oh wow, I see your point. How could I have been so wrong?

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    3. Anonymous12:32 AM

      The juvenile snark is unbecoming.

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  10. Anonymous9:09 PM

    There is a long interesting string of comments at the Atlantic following this piece.

    My opinion: only an academic who has never had to completely support himself and a couple kids on minimum wage or a series of temp positions could write this and believe it.

    My experience: Over 45 years of working for corporations I accumulated savings. IRAs and 401k balances at each job and then used that money to live on when I got laid off and searched for new work. Each time I got laid off I was older. And each time because of that fact finding a new job took longer and the new job paid less making it impossible to replace the savings I had used to survive.

    Good luck to you Noah but I suspect that in a few years you'll repudiate
    this smug piece of writing and excuse yourself for being young and inexperienced.

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    1. My experience: Over 45 years of working for corporations I accumulated savings. IRAs and 401k balances at each job and then used that money to live on when I got laid off and searched for new work. Each time I got laid off I was older. And each time because of that fact finding a new job took longer and the new job paid less making it impossible to replace the savings I had used to survive.

      So after that, did you just end up wishing you had never accumulated those IRAs and 401k's, and had just consumed everything you earned the minute you earned it?

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    2. Anonymous12:29 AM

      You're are dodging the point I made which is that one can play by the rules, work his ass off, and the system being what it is, still end up with little to no retirement savings.

      You'll get your comeuppance one day and it's going to be a rude awakening. On second thought, perhaps not--you likely have a mommy and daddy to turn to when you are in need.

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    3. You're are dodging the point I made which is that one can play by the rules, work his ass off, and the system being what it is, still end up with little to no retirement savings.

      No, you are dodging the point I made, was that you would have been in a lot bigger trouble had you not saved!

      You're bitter because you kept getting laid off and your salary kept going down (which sucks). You're taking it out on people who say you did the right thing by saving instead of spending everything you earned. But that's not who you should be upset at!

      You'll get your comeuppance one day and it's going to be a rude awakening. On second thought, perhaps not--you likely have a mommy and daddy to turn to when you are in need.

      I'm sad that your career has turned out shitty. It makes me really upset to hear about that. And if that has really turned you into a bitter guy, hoping for the failure of others, then that's a double tragedy.

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    4. Anonymous10:59 AM

      Concern troll!

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  11. Noah -
    Great piece. I've been teaching personal finance this semester as well, so I'm similarly struggling with how to express a lot of these difficult ideas myself, in the classroom and in my blog www.bankers-anonymous.com
    I can see from the comments you've hit some raw nerves.
    I wonder if the some of the disconnect comes down to the big difference between simple and easy. Meaning, you've clearly stated fixes, in simple terms, that would lead to long-term better outcomes for poor and middle class folks. Fundamentally I think you're right.
    But it's not easy - at all - to implement what are really radical adult behavioral changes. If it was easy, there'd be far fewer poor people. But suggesting simple ways of conceiving of the problems and solutions - as you have done - is an important contribution to the dialogue we need to have.
    Thanks for writing it.

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  12. Bill Ellis10:44 PM

    Noah, Your Idea is heavily dependent on the stock market.
    I have seen different charts that show the stock market in real dollars. They very by quite a bit ?!? The most stocks-as-an-investment-critical-sources seem to show that stock have not gained much real value for some time.
    Other charts show real gains over that time, but they also show long... scores long... flat periods with no real gains.
    It seems that flat periods are unavoidable. Periods of 20 or 30 years of flat growth would mess up the effectiveness of your solution... right ?

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    1. It seems that flat periods are unavoidable. Periods of 20 or 30 years of flat growth would mess up the effectiveness of your solution... right ?

      Well...yes, except that really, investment should be in a mix of risky assets, which includes commodity ETFs and bond ETFs...it's very rare for all risky assets to go flat at the same time...

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    2. bjdubbs11:42 PM

      Don't commodity ETFs consist of futures, and futures are zero sum? And mean reverting. It's true that some pensions put money in commodity funds, but the net return of all futures participants is less than zero.

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    3. But ETFs aren't the full universe of futures buyers.

      In any case, commodities are in there in order to provide a bit of diversification...they shouldn't be that large of a part of the portfolio.

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  13. Bill Ellis11:02 PM

    Noah ... I found it very interesting how you equated "Entitlements" ( I prefer the term "earned benefits") with wealth.
    I agree completely... if I get you right.
    Convincing Americans to equate their earned benefits with their wealth would sure put a different spin on the Tax/budget debate.

    How would it sound if the media talked in terms of Paul Ryan wanting to cut the wealth of average American instead of cutting their entitlements ?

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  14. Do we need the poor to save more? Is there a capital development shortfall due to the fact that the poor are not saving enough? Is there a national shortage of funds for investment? The last I heard firms are swimming in liquid assets. And even if there were such a shortfall, isn't it more sensible to draw the needed additional surplus from those who actually have a surplus?

    If there is no such shortage, then why not let the poor - who can't really afford to "delay gratification" - keep their income and consume it all, and then we can deliver exactly the same income to them in the future via redistribution that they would have earned via investment in the modest financial assets they can afford. What's the problem with this? It's not virtuous enough?

    Why tell the most vulnerable people in our society that they will only be eligible for that modest future income if it comes from a cash flow from financial assets they purchased over their lifetime by scrimping? Is this sensible, efficient and decent - encouraging the least fortunate to set aside part of what little they have to provide society with capital funds it doesn't need and that can be acquired elsewhere? In addition to humiliating the poor with poverty do we also have to humiliate them with degrading paternalistic lessons on capitalism and the virtue of a penny saved?

    It's bad enough that a sizable number of people in our society pull down substantial economic rewards by buying ownership stakes in the labor output of their less fortunate fellow citizens, and are thereby able to accumulate wealth from idleness. So now we even have to turn the poor into capitalist bedbugs munching their tiny bits of extra flesh from people who work?

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  15. Bill Ellis11:13 PM

    How about a government system that communally invests in the stock market, but guarantees an minimum return on longish term investment...say after five years ? It could work kinda like an insurance program, spreading the risk of hitting periods flat or declining returns over time and population ?
    I dunno.

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  16. Anonymous11:46 PM

    Noah:

    From what I have read, Australia and The Netherlands have something similar to our 401(k) system, except with less of the drawbacks. Do you have any thoughts on those countries' systems?

    Do you think taxing consumption a little more, giving less of a preferential treatment to housing (eliminating the mortgage interest deduction), could be good nudges?

    Frank

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  17. John S2:46 AM

    If we want to help lower income workers, why not cut (or abolish) payroll taxes, which are highly regressive? It would stimulate employment (by lowering the cost of hiring workers), increase take home pay, and even stimulate consumption.

    Re: wealth inequlity--it would help not to give implicit corporate welfare like too-big-to-fail guarantees, which according to one study account for nearly all of the big 5 banks' profits.

    http://www.bloomberg.com/news/2013-02-20/why-should-taxpayers-give-big-banks-83-billion-a-year-.html

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  18. Noah:

    I agree on your statement that wealth distribution will be very different in 30 years, but for different reasons. There is a trend in wealth distribution since the Second World War. For 93% - the increase in economic activities for the last years for the 1 % - the US is now a plutocracy. And any mediaeval king would be proud about the popular support the American democracy has. The pendulum has reached an extreme. If history is a teacher, it will swing back. Game changers for the political equilibrium like a war or a systemic challenge to capitalism as the Soviet Union are not on the horizon.
    The challenge is how to frame “The-winner-takes all-markets” without loosing incentives. Education is not a solution, the welfare state and redistribution are already at their limits, as Europe demonstrates. “True progressivism”, as proposed by “The Economist”, has not reached political support.
    Models, tools and analyzing techniques are embedded in an institutional and political framework. For most of the time this works fine. But there are turning points, where some reflection about the limits of Econ 101 might be appropriate.

    Noah Smith’s statement is iconic: “If they have no wealth, let them save more”, a minor alteration of the expression “If they have no bread, let them eat cake” on the eve of the French Revolution, often attributed to Marie Antoinette. As I was born in Eastern Germany, I thought that I am immunized against the communist obsession with other people’s profits. But ignorance and fine-tuning of existing solutions is not an answer. Maybe creative thinking starts when we acknowledge that there is a problem?

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  19. Noah,
    I think you are missing something here. The big killer for wealth accumulation for poor people is unemployment. It is not that they don't save in good times, it is that they dissave in bad. What you really need is more economic security.

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    1. Well, maybe. What we need is a way to prevent long-term unemployment. Short-term unemployment can be useful for job switching and thus for wage bargaining.

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    2. But only if there aren't any liquidity constraints like mortgage, student debt or family. And the most important constraint, family, is usually a publicly observable information.

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    3. Noah - people can be "pulled" from one job to another. They don't need to be pushed or jump. You must be aware, that many employers won't even consider somebody who is currently unemployed.

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  20. Noah, isn't there a cousin of the "paradox of thrift" somewhere in the neighborhood here? Given the the total return on aggregate investment, the purchaser of certain kinds of investment vehicles can expect high, compounding returns. But if the nation as a whole increases its savings rate and reduces its consumption, the result might be economic stagnation, meaning that the marginal rate of return on additional savings goes to zero.

    This is just an extension of the point I raised above. As a nation, we don't need the poor to save more. It is better for both us and them if we let them keep and consume what little present income they have to meet present needs, and then provide them in the future with a share of the national output that will grow over time as the result of the investments the rest of us make with our vast aggregate surplus. The poor don't really have a surplus, so we shouldn't be trying to compel or encourage them to turn part of their income into an artificial surplus.

    The problem of poverty is not individual behavior; it is social structure. The way to end poverty is to structure our society so as to (a) provide a job to each and every person willing to work, and (b) change our system of compensation to that the gap between the lowest paid workers and the highest paid workers is much, much smaller than it is now.

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    1. I'll put in with Asher below, I think Dan raises an interesting point with paradox of thrift concerns. Possibly, it is more efficient to strive for a societal "floor" to our standard of living which allows the poorest a decent life while savings remain largely in the domain of the middle and upper classes.

      Where I have some issues with Dan is I don't think he acknowledges sufficiently the defects of human nature. There is such a thing as sloth and it's related malaises and we should be vigilant against encouraging or enabling it unnecessarily.

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    2. I wish Noah spent as much time on the interesting comments as he does on the "this piece is crap!" stuff.

      Wrt the defects of human nature -- that's where a "politicized" discussion has really become harmful. Those who support something like welfare programs are motivated to downplay systemic abuse, and those who don't like them are motivated paint everyone on such programs as lazy.

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    3. Yes.

      As the great I.F. Stone once said, you can't have freedom without its abuse. Same goes for the security of a safety net. But balance is what it's all about. Too much freedom or too much security doesn't cut it.

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  21. Noah, reading this article and your responses to some commenters, I am reminded of this comment by
    James K. Galbraith:

    "... "extreme capitalism": the obsessive, uncritical penetration of the concept of the market into every aspect of American life, and the attempt to drive out every other institution, including law, art, culture, public education, Social Security, unions, community, you name it. It is the conflation of markets with populism, with democracy, with diversity, with liberty, and with choice---and so the denial of any form of choice that imposes limits on the market. More than that, it is the elimination of these separate concepts from our political discourse, so that we find ourselves looking to the stock market to fund retirement, college education, health care, and having forgotten that in other wealthy and developed societies these are rights, not the contingent outcomes of speculative games."

    You are calling for speculative games. Most people would rather have rights and pay for the social insurance. At least then you know what you are getting. That's one of the reasons I took a 50% pay cut to become a public school teacher, after about 4 hi-tech layoffs. And your financial strategy does not help when everybody's 401K becomes a 201K due to market variations. Speculative games.

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    1. This is a great point, IMO.

      I'm definitely one of these people. Gambling doesn't appeal to me, but saving under the mattress is useless. I'd rather pay into a public good I can feel good about.

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  22. The article almost feels like an experiment in whether people will respond to an economic argument with moral or emotional reasoning.

    Still, I think Dan Kervick is making some points that I'd like to know the answers to. Do we really need the poor to save more? Can poor people really be seen as having a surplus?

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  23. Anonymous10:03 AM

    I don't mean to be disrespectful, but this article is absolutely preposterous and it completely glosses over the evils of the extraordinary income inequality plaguing America. Yes, it is a plague. It is unsustainable and it is also criminal. Criminal -- because the reason why there is so much inequality is the system is rigged in favor of the wealthy elite. There is virtually no upward mobility that takes someone into the 1%. OK, there are the Bill Gates & Zuckerberg's, but they were both at Harvard don't ya know.

    I grant the author the following point: yes, poor and middle class families could stand to be more thrity and save more of their paltry income. It could be the difference between living in an apartment and living in a house. You get into a house, a better neighborhood, your child goes to a better school and maybe goes to college and the cycle continues.

    But to treat "savings" as solution or even as a counteracting measure to the vast income inequality is just flat our dishonest.

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    1. It's not a solution to income inequality!!

      But consider this. Why don't Americans vote for more redistributionist parties and leaders? My guess is that they try to use unsustainable debt to pretend they're winning at capitalism and don't need redistribution. Not borrowing unsustainably = saving more! And I think it would also make more people realize their true class interests...and demand policies to rectify the unequal income distribution!

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    2. Well, back when I used to teach philosophy, this question used to come up from time to time, and my overall impression was that Americans have been raised to believe that everyone gets what they deserve, and so if one has less than others that is attributable almost entirely to one's own moral or biological inferiority, and that it is the natural and just order of things that the inferior should have less.

      Middle class American social ethics are filled with nostrums such as "Play with pain"; "Don't be a victim"; "Stop whining"; "Suck it up"; etc.

      On the issue of debt, I don't think Americans of the recent past had taken on debt as a way to pridefully hide their "real" condition. We were all taught that debt is a totally normal and healthy part of life: that all that borrowing and lending made the whole system go and that it was perfectly appropriate to have a substantial balance of debt which could be continually rolled over as incomes increased - as they would. Buying a home and carrying a huge mortgage, for example, was presented as the ultimate in middle class virtue. And it was seen as no different from the way every kind of business ran: using debt financing to build prosperity in the present from the rationally expected gains of the future.

      The problem I have with the "save more" directive is that the message it sends is that inequality is primarily a result of the deficiencies of individuals with bad habits.

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  24. Ah! The paradox of thrift. A thrifty America would be an interesting place.

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  25. This column is shockingly bad. It completely confuses an individuals wealth with an individual's share of wealth of a country.

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    1. I think this represents a fallacy of composition solution.

      In very round estimates, with many simplifying assumptions:
      The net worth of Households in the US is 60 Trillion.
      The bottom 60% own roughly 10% or 600 Billion

      Your solution is to have the bottom 60% increase their assets so they can at some point live off returns on/of capital rather than on income.

      So if 60% of 315 million people each had enough assets saved to earn $10,000 at 5% that would require 37.8 Trillion in new assets. However, remember that you want to do this with no redistribution, so that 37.8 Trillion would need to be only 10% of assets so the Net Worth of US Households would need to be 378 Trillion.

      I know you have age cohorts etc to consider, and you didn't outright exclude a reduction of inequality. But I think this illustrates that your proposal is the incorrect path to pursue from a policy perspective. Why? I'll leave it to whomever reads this to think through the implications, but its doubtful there are that many productive investment opportunities, and in any case it is all unnecessary, we already have enough wealth and income in this country to comfortably provide for all citizens, working retired children etc. We don't have a wealth/Income problem, we have a wealth/Income distribution problem.

      This is an incredibly difficult problem to optimise, clearly 'socialism' has shortcomings, as does pure 'capitalism/market based solutions' - it hardly makes sense to address it all here, but wishing away inequality as part of the problem, and simply assuming there to be en essentially infinite number of productive investments seems like a stretch.


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    2. If you want to avoid this awkward result of composition, you can either suggest that higher savings by the 60% will reduce inequality in the future, in which case you have to demonstrate that saving is the best public policy measure to achieve that goal and that it will actually work, which would be very improbable given the advantages of compounding accrue to those with wealth, its hard to see the math that would allow the 60% to catch up (all else equal).

      The other problem is that In the actual world, poverty comes encased in barriers to success including, illiteracy, despair, discrimination, undernourishment, ill health and crime. These problems in turn are due to the lack of a vast and necessary infrastructure of schools, transportation, communications, public health and safety, finance and markets.

      These are “public goods” typically provided by governments or with the help of governments.

      If you want to provide these public goods with the aim of achieving higher self-improvement by the poor (including through increasing saving and thrift), you have to tax the people who have wealth and income now and indirectly redistribute that through government investment in public goods.

      Either way brings you back to addressing the real problem which is distributional.

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  26. Did you know that the president's 2013 budget proposed requiring employers to offer their employees the option of automatically diverting portions of their paychecks to an IRA? Employees would be asked to choose whether to participate or opt out, but for those who don't make a choice, the default would be to divert 3% of the their paycheck to an IRA. Nudges FTW!

    See page 49 of this document for details: https://www.jct.gov/publications.html?func=startdown&id=4465

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  27. This comment has been removed by the author.

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  28. A couple of other things worth looking into in connection with the issue of return on investment: the affluent are sometimes permitted to buy high yield financial assets that ordinary people are barred from purchasing.

    Also, one thing that enables a high return on financial investment is that many investment vehicles are derivative products that generate cash flows for creditors from the interest payments of borrowers. The lower down the income ladder you go, the more likely it is that a person will be a net borrower rather than a net creditor. So there is already a strong class division built into the financial system as it exists, and that supports its profitability. The need of the lowly is exploited as a source of income for the not-so-lowly.

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    1. But is borrowing a "need" of the lowly? Only if you think that using debt to pretend you're richer than you are is a "need". If people didn't disguise their poverty with unsustainable borrowing, they might be more willing to vote for leaders who support actual redistribution. As it is, people pretend that the unfairness of the system lies in the fact that it asks you to pay back your debt, rather than in the unequal distribution of income itself. So people vote for Republicans, trumpet the virtues of unfettered capitalism, then borrow more than they can afford in order to sustain their pride with the illusion that they succeeded at capitalism...until it all comes crashing down around their heads...

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    2. Bill Ellis4:54 PM

      Noah asks..."But is borrowing a "need" of the lowly?"

      It is for a lot of collage kids.
      If the "lowly" invested as you recommend would they be able to send all their kids to collage ?

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    3. But Noah, how come it never comes crashing down around them? Its the invisible bond vigilantes Krugman keeps going on about. Our government "borrows" in its own obligations: http://neweconomicperspectives.org/2013/03/the-i-o-u-in-the-u-s-dollar.html

      And you should really read J. W. Mason and Avinash D. Persaud's paper from INET on consumer debt. It turns out the majority of Americans have not become more indebted because they have borrowed more: they have become more indebted because as the bench mark interest rate went down, the effective interest rate paid by most Americans went up.

      Americans became more indebted without borrowing more so they experienced none of the exhilaration enjoyed by GOP congressmen waging irresponsible and illegal wars. However those GOP congressmen are now insisting ordinary Americans pay for their wars along with personal debts that mount without benefit for debtors who only experience the pleasure of paying. The mass of irresponsible Americans is another GOP myth, they exist, but in no greater proportion than anywhere else. It is the system here that is rigged so that even and particularly the responsible loose.

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  29. Hi, Noah;
    The basic points you raise are probably good ones. The overall effect, alas boils down to "simple answers to complex questions". Sometimes simple answers are useful. Sometimes they aren't as helpful as you might think (Want to lose weight? Eat less and exercise more!). Yeah, it's certainly true that being cheap and saving more would make a big difference, in the long run. In the short run, though, that point 1 looms very large indeed. When a good month is one where you don't go further into the red, tweaking how frugal you are isn't going to help a good deal. You're generally already being as cheap as you can be. When you can only put $5 into savings one month, and the car dies and needs a $600 unbudgeted repair the next month, being cheap actually hurts you (in the sense that being cheap often includes skimping on necessary maintenance or doing the repairs (poorly) yourself).
    Sure, being poor involves making poor money decisions. So does being rich, but then being rich means you can generally absorb them. Being poor also involves not being able to shop around for the best price, but taking what you can get; not being able to get low-rate lines of credit when needed; not being able to buy in bulk and save money, but buying the smallest amount you can get and paying the premium for it. It's hard to break out of being poor. How many kids in pro sports came out of the projects? How many kids are there in the projects? With all due respect to Ben Carson, how many successful MDs came out of his childhood neighborhood. I know that neighborhood. I can tell you, damn few. It's comforting for us to tell ourselves that we were just more noble and moral and smart and hard-working than our peers, but in my experience there's a lot of luck in there, too. It's a whole lot easier to score when you're born on third, but some of us can still manage to scrap our way to third even if we start out as light-hitting backup second basemen. Most of us won't, of course;
    so many things can go wrong on the way. The same is true to a lesser extent when you're not quite poor. So, in essence, you could well have stopped at the first bit. Correct the massively skewed redistribution of the wealth to the guys who have most of it already, and you can work on the rest of the problem. Until then, you're thoughtfully discussing how better nutritional choices would help child-rearing in East Africa.

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  30. Anonymous12:50 PM

    "I'm not talking about teaching kids the Capital Asset Pricing Model." What?!?!?!? Why not? CAPM is a world-famous, award-winning, now-with-no-trans-fat theoretical financial tool that is absolutely worthless in real world (sorta like republican philosophy -- can't tax the job creators!)

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  31. Noah,

    The column reads like Econ 101 stuff - it mostly ignores real-world constraints. You got one constraint right, health shocks. Their effect is blindingly obvious because they cause so many bankruptcies. But you need to take off the sunglasses and consider other significant constraints that may not be as glaring, but aren't exactly hidden either (and I bet they are all well-known to you).

    The way our society is structured, you can't earn anything without investing in your career (i.e., spending money), even for low-paid jobs. Most Americans can't get to work if they don't have a car. And you can't buy "just a little" car. Unlike in Econ 101, real-world purchases aren't infinitely divisible. You can't buy a Tata in the US. You can buy a used car, but if you go too cheap, you'll be hit by high maintenance cost and lost time (i.e., missing work) when the car is in the shop. Most non-luxury cars, new or used, cost about the same per year to own. That means a worker earning $20,000 per year has to absorb roughly the same transportation cost as you do. Places with decent public transportation are usually too expensive for that worker to live.

    For a better job, one generally has to finish college, which typically means accumulating debt, and a special kind of debt that cannot be erased in bankruptcy.

    Health care is not the only need that should be a right but is a privilege. Safety is very unequally distributed. It costs more to live in a safer neighborhood. School quality (much of which simply reflects the location) is another very unequally distributed commodity. So, to raise a family and invest in your children's future, you need to move to a safer neighborhood with better schools, which costs a lot of money. Places with good schools tend to have few rental apartments and a lot of single-family houses. Not everybody has to buy a house to live in a good neighborhood, but, in practice, a lot of people for whom it would be financially better to rent are forced to buy a house and thus take on more debt. Besides, renters are often at the landlord's mercy and (other than in NYC and a few other urban centers) there is some degree of stigma associated with renting beyond a certain age. And again, you can't buy "just a little" house. In fact, the whole point of "good neighborhoods" is that they achieve that status by excluding poor people. So, if you are trying to "move up", you must spend beyond your means.

    Now, when you add these constraints to health care shocks and unemployment spells you already acknowledged, you have pretty much explained why the bottom half - or maybe three-quarters - of the income distribution simply cannot save anything worth a mention. Or they have to choose between saving money and investing in their children's human capital.

    Since there is a bit of an overlap between my area of work and financial services, I occasionally talk with financial planners and advisers (mostly about retirement planning). They generally say they can't be useful to the bottom 50-75% of the population by income - they can't afford their advice, and even if they could, they have so little it would do them no good. The top 1-2% will be fine anyway; the rest of the top quartile are the people financial planners "worry" about.

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  32. Fargoan3:12 PM

    The other day I was invited to one of the residence halls where I teach to talk about the benefits of saving and early investing. Students were mostly freshmen or sophomore. The main challenge is that they didn't have enough income, so all what they could do is to invest in penny stocks and they were asking me about that. So earning income should come first and then saving and investing should follow. Poor people could save more if they have earned more. But simply their earnings barely meet their basic expenses. I agree that they need to be more educated about personal finance and make better decisions, but simply you cannot blame a poor person for not saving enough money when they don't have that money. Poor people also eat unhealthy food which is a very big problem for future generation. The government will have to allocate more money to treat these people under Medicare etc. So why not giving these people more reasons to eat healthy? I hate seeing so many TV commercials about junk food. Frugality and saving should not come at the expense of future health problems. Another point, poor people may not be saving just because they are complacent that the government will take care of them in the future. I guess poor people save more in countries where the government pension system is not developed or people have less trust in government. So they try to take care of their future by saving. Also investing in stock markets will cause more problems for poor people when markets dive, because they don't have enough cushion as rich people do..thanks for the post, great to think about..

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  33. Just one question: how do we know poor people are worse at investing money than rich people? I am well off, but I know working poor. I noticed that they spend way more thought and time on money and wealth then I do. But their financial priorities are much different from the well-off. Their constraints are liquidity and running costs. So time and energy spend on learning how too repair a toaster might bear much more gain then learning how to open a custody account. And the Madoff story thought us even very rich people are easily conned. The perceived advantage of rich people could also simply be that bankers consider them as equals and are more hesitate to screw them. I'd like to link a very angry (and vulgar) article on cracked.com that describes what it means to be poor. And how pointless the idea of saving or working one's way up it. http://www.cracked.com/blog/5-things-nobody-tells-you-about-being-poor/

    Also I don't like the basic premise of the article. It implies the problem (or part of it) of poverty is that the poor are inferior to the rich because of lesser skills. This is the classic tale of the foul underclass that has been used to avoid change for centuries. A few years ago I read about the history of health care in Germany in the 19th century. Living conditions were bad, and workers were treated like crap. But the popular explanations by government and high society for this was that workers very simply too often drunk and wasted their money at all opportunities. One of the suggestions to solve this was to found small banks and make worker's save more. This was a good idea and helped to develop a better banking system. Today in Germany semi-public banks offer basic financial services to everyone and are required to offer a bank account for everyone. But this didn't solve the problems of the 19th century, and even interfered with the actual solutions. The article above is the newest incarnation of this; well-meant, a good idea, but distracts from actual solutions. Consumer protection, more worker rights, increase of social security and the ending of the preference of capital income in today's tax systems.

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  35. The traditional middle class way of saving is to pay down a mortgage. It works rather well. It's not an improvement to 'nudge' such people into speculative investments. That would only engorge the financial sector.

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  36. Clearly a lot to say here, as I've been teaching personal finance at the University of Arizona since 2005, but not that much time right now. I'll say quickly, that I think the best personal finance book by far is by Elizabeth Warren, with her daughter, "All Your Worth". I've been using it in my personal finance I course since it came out in 2005. It's a quick (and interesting and fun) read, and an absolute must if you want to understand personal finance well today.

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  37. You note some important things. One huge thing that's missing is education on careers and education -- so many people make terrible choices on the career to go into, and how to go into it and succeed, and on choice of education and how to pursue it. The result is often far worse income and/or income security throughout life.

    And there are traps that they need to know about, like worthless predatory for-profit colleges with massive, ultra-high interest private student loans that can never be escaped in bankruptcy (with extremely rare exception) since the 2005 bankruptcy law.

    I include education, careers, student loans, etc. and have a career plan research assignment where they have to research in depth a first and second choice career.

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  38. Wow. Just Wow. I think in the end you're suggesting the following:

    The poor wouldn't be poor if they had more money. Well, duh.

    To suggest that this is a notion of personal habits is simply saying that the poor are dumb, have poor morals, are uneducated, or whatever. These all may be true, but don't do anything to deal with the problem. (I'm assuming a problem here.)

    To suggest that the poor save their way to wealth is just silly. Wealth is always relative. If what you want is a redistribution to make wealth in the country more equitable, it is easy to achieve. Simply provide well-paying jobs to all who want one. Infeasible? How about having the government providing stipends to all citizens? Don't like that one? How about taxing wealth away from the rich? Maybe you could suggest some ideas of your own.

    You seem to have some measure of sympathy for those who are less well off than yourself, but you seem totally unwilling to admit that it is the system that we have created in turn creates and controls us. It is our particular experiment in market capitalism that to a large extent determines outcomes, not personal behavior. If you truly don't like the results, you must change the system. I'll admit that such a notion is difficult in philosophical terms for many (the system itself creates a moral sense in its actors), but it's better than suggesting that people self-extricate from a situation in which they really have little control.

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  39. Isn't the problem with this that savings rate is controlled, not by income, but derivative of income, as much as time preference?

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  40. Another thing that just occurred to me: wouldn't a higher savings rate for the middle and under class create economic distortions? They have the biggest investment opportunities; they can invest in inventory (for example the the heating in their houses), investment goods (like a more energy efficient car), and work skills. And since they start from a lower level, the yields will be much higher than financial investments. From an economic view the poor and middle class should be in huge debt, but the risk should be mitigated to the rich and the banks.

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