A major lesson from the COVID-19 shock is the importance of maintaining an appropriate level of savings for a “rainy day,” something we must appreciate as individuals and as a nation. Indeed, this has become a societal imperative for all Americans.
The savings rates in America are abysmal by most standards. At the household level, the personal savings rate is among the lowest in the world and has consistently declined over the past six decades. In 2019, the personal savings rate was a mere 7.6%, compared with 10.4% in 1960. The household savings rate, at 4.9%, puts the U.S. behind many nations in the Organization for Economic Cooperation and Development (OECD), making Americans among the worst savers globally.
At the national level, the ratio of gross savings to gross domestic product (GDP) stands at 24%, which compares poorly with other high-income nations such as Singapore (48%), China (46%), South Korea (35%), and Germany (29%).
Low savings normally dampen capital investments and the GDP growth rate. The size and wealth of America has shielded us from the consequences of low savings and high debts. Nevertheless, meager savings has left millions of low-income households and the national economy highly vulnerable to a severe crisis such as COVID-19.
One consequence of low savings is a burgeoning national debt. Not surprisingly, the U.S. federal government debt, which is approaching $27 trillion, is at historic highs, and the federal government budget shortfall – or deficit – this year is expected to exceed $3.5 trillion.
One measure of national debt is the debt-to-GDP ratio, which compares a nation’s public debt to its gross domestic product. According to official statistics, the U.S. debt-to-GDP ratio was 105.4% in 2017. For perspective, the nation’s highest debt-to-GDP ratio was 121.7% after World War II in 1946 and has been as low as 31% in the 1970s. The $2.2 trillion Coronavirus Aid, Relief and Economic Security Act package passed in the U.S. Congress in March 2020, although timely and appropriate, will greatly add to the national debt.
Germany has also launched gigantic public spending to cushion the impact of the pandemic. However, it has done so by drawing down reserves built over the boom years. This is the responsible strategy as a nation.
Unfortunately, in the past, we ran large budget deficits year after year, fueled primarily by hundreds of billions of dollars of tax cuts during the recent boom years. These are missed opportunities for the Federal government to build reserves and pare down the national debt. These steps would have prepared the nation to face inevitable economic storms such as the pandemic we face today.
Debt is not necessarily a bad thing, especially if the government borrows money to invest in education or infrastructure, making the economy more productive. However, when debt is used to enhance consumption or the wealth of a section of the population, it weakens the economy and becomes a burden on future generations.
At the sectoral level, even before the pandemic, a big concern was the burgeoning student loan crisis, with $1.43 trillion in debt depressing overall attainments in education and forcing difficult choices upon 44 million young people.
Why is savings so critical to the long-term welfare of a household, business, community, or nation? Savings provide insurance against an unexpected crisis. For a municipality, city, or state government, a rainy-day fund helps it survive periods of economic stress, just as we face today.
Poor savings habits endanger individuals and institutions. Even small setbacks would cause severe stress or even a collapse. A business that failed to set aside rainy-day funds could face bankruptcy if the owner unexpectedly falls sick or the economy hits a road bump. Low savings magnify economic pain during a crisis.
We did not arrive at this situation overnight. These are the results of decades of federal government policies under many administrations from both parties. An increase in national debt reflects our collective failure to save adequately to pare down the federal budget deficits, set aside funds for the proverbial rainy day, and leave our children and grandchildren a debt-free economy.
A disturbing aspect of the low-savings picture at the household level are the structural and systemic inequities, which lead to lower wealth creation among minority communities. A Washington Post article presents the startling statistics that the median net worth of white households is nearly ten times higher than that of black households. Nearly 20% of black families have zero or negative net worth, compared to 10% of white families.
Munir Quddus, Ph.D.
As we emerge from this calamity, we must change public policies and personal habits to enhance our savings culture. Behavioral economists have presented a range of ideas on how the nation can encourage savings at all levels of society. At the personal level, the basic rules for building savings and wealth are simple. Experts recommend that we start early, consistently saving an increasing portion of our income. Over time, the power of compound interest will do the magic. With near-zero interest rates, one must also diversify one’s investments to include equities, which have historically outperformed other asset classes.
Great nations do not burden future generations with huge debts, crippling innovation, and prosperity. We should learn from the wisdom passed on by Benjamin Franklin: “If you would be wealthy, think of saving as well as of getting,” and “the second vice is lying, the first is running in debt.”
Munir Quddus is a professor of economics and serves as the dean of the College of Business at Prairie View A&M University.