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.