Contra Ethan Gach, the poor can save without wrecking the economy

In the continuing saga of responses to Noah Smith’s article about the poor and their savings, squarelyrooted chimes in:

Hmmm, I wonder what would happen if everyone started saving as much income as they reasonably could? Where would the high yield investments be with so much capital sloshing around? How would the markets react when aggregate demand plummets even further? – Ethan Gach

 

Snark aside, the key here is that, while it would benefit any individual poor person to save more (assuming, of course, that’s possible given their income and cost-of-living, which is not an assumption I’m eager to make), if every poor person somehow stumbled onto Smith’s article and tried to save more it might generate economic disequlibria that wouldn’t benefit anyone. This is semi-related to the point I’ve made before that aggregate saving is a very different animal than individual saving.

This is just not true. I wish it were true, because it means the poor actually represent a more than insignificant part of our economy. It’s not true for the same reason Noah wrote his article: the poor have no cash savings.

Let’s take a model economy where the top 20% are “rich” and everyone else is “poor”. Let’s be generous and assume the rich control only 80% of the wealth when, in our economy, that figure is far higher. Let’s also stipulate the total value of this economy is a million dollars, and the poor’s aggregate savings grow at 2% per annum against the rich whose grow at 10%. I’ll be conservative and model this with a constant returns on capital across the rich and poor. This obviously isn’t the case, but it doesn’t need to be.

So what we have is 20% of the population controlling $800,000 and the remaining 80% controlling $200,000. At the initial savings rate for the poor, this is what the economy will look like in 10 years:

Year

Poor

Rich

Ratio

1

200000.00

800000.00

0.25

2

214000

920000

0.2326087

3

228980

1058000

0.2164272

4

245009

1216700

0.2013714

5

262159

1399205

0.1873630

6

280510

1609086

0.1743290

7

300146

1850449

0.1622018

8

321156.3

2128016

0.1509182

9

343637.2

2447218

0.1404195

10

367691.8

2814301

0.1306512

11

393430.3

3236446

0.1215624

12

420970.4

3721913

0.1131059

13

450438.3

4280200

0.1052377

14

481969.0

4922230

0.09791680

15

515707

5660565

0.09110519

Now, let’s consider that the poor triple their savings rate to 6%:

 

Year

Poor

Rich

Ratio

1

200000.00

800000.00

0.25

2

222000

920000

0.2413043

3

246420

1058000

0.2329112

4

273526

1216700

0.2248099

5

303614

1399205

0.2169904

6

337012

1609086

0.2094429

7

374083

1850449

0.2021580

8

415232

2128016

0.1951264

9

460908

2447218

0.1883394

10

511607

2814301

0.1817884

11

567884

3236446

0.1754654

12

630351

3721913

0.1693622

13

699690

4280200

0.1634714

14

776656

4922230

0.15778540

15

862088

5660565

0.15229721

I’m not posting a table to vindicate the obvious, but the portion of aggregate savings allocated to the poor will continue to fall until their savings rate is equal to that of the rich, or 10%. This means that it’s highly unlikely that even a significant increase in the savings rate of the bottom 50% (which, in terms of wealth not income, are poor as far as our society is concerned) will cause any “disequilibrium effects”.

Indeed, the ability of the poor to affect our capital markets are even more dispersed in our economy. Because of high levels of risk aversion and poor investment practices, it’s unlikely that they will earn the same rate of return on their savings as the rich. The wealth distribution I assumed is also a lot more equal than what America actually is.

So, contrary to hazy economic thinking, nothing will happen to interest rates and investment markets if we encourage the poor to save. It would be irresponsible to think so because of what Mr. Ethan Gach says. Time to look at the numbers.

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