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Work and prosperity
28 March 2013

The poor should save more and the rich should save less

For any given level of income inequality in any particular place, wealth inequalities are usually much greater.

But, so what, asks Noah Smith in the Atlantic. Consumption is surely what matters in terms of real human experience and you can’t consume what you’ve got in the bank or stuck in some other investment:

  • “...let the rich sit on their useless stock portfolios like Smaug the dragon sitting on his giant pile of gold.”

But, actually wealth does make a difference, he says:

  • “...though there is a wealth/consumption trade-off in the short run, in the long run there is quite the opposite; the rich, it turns out, make a hefty chunk of their income from the returns that accrue to their wealth.”

In other words, money comes to money. It is an important point and one that is rather overlooked by rightwingers who believe that taxing wealth is preferable to taxing income. 

Leftwing advocates of wealth taxes, with their redistributionist motives, also miss a few important points:

  • “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...
  • “If you do the math, you discover that in the long run, income levels and initial wealth (factors 1 and 2 from above) are not the main determinants of wealth. They are dwarfed by factors 3 and 4 – savings rates and rates of return. 

Therefore, redistribution, whether of income or wealth (they come to much the same thing) “can't fix all of the problem, or even most of it”:

  • “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.
  • “...this sounds hard, but actually it is probably very doable. For years, behavioral economists such as Richard Thaler have been studying ways to ‘nudge’ people to save more. The most famous ‘nudge’… is to make employee pension plans ‘opt-out’ instead of ‘opt-in’. But there are plenty of others. In lab experiments, just giving people information on how to save money makes them save a lot more.”

Smith advocates better financial education in schools and action to make it easier for ordinary people to invest in stocks and shares.

But there’s something even more important that governments should be doing – or rather something that they shouldn’t be doing.

Ever since the credit crunch, governments have bent over backwards to protect the investments of the wealthy, while showing disregard for the ordinary saver. Quantitative Easing, for instance, drives down the interest rates for bog-standard saving accounts, while driving up share and commodity prices, in which the wealthy are more likely to be invested. Meanwhile ‘haircuts’ for major creditors are the exception, while the norm is to transfer the burden of bad bank debt on to backs of current and future taxpayers. 

This needs to change. There’s no reason why the rich should be protected from the consequences of loaning excessive amounts to reckless financiers and spendthrift politicians. They need to be fully exposed to risks that they’ve freely entered into. This would encourage them to save less and spend more. Alternatively, some might consider the honest, eyes-open, skin-in-the-game risk of investment in real business ventures. Either way, it would be good for the economy. At the same time, governments would be able to shift their efforts to encouraging the rest of us to save, ultimately resulting in a more equal distribution of wealth and a less dependent population.

Unfortunately, as long as governments have deficits to fund, they will remain focused on pleasing those who already have the wealth – which is something that advocates of even higher public borrowing really ought to think about.


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