Tyler Cowen of
Marginal Revolution (along with a number of my own readers) has asked about
this statement by Michael Mandel:
Let’s do the calculations. Over the past 10 years, the U.S. has run up an accumulated goods and services trade deficit of roughly $3 trillion. Sounds like a lot of money, doesn’t it?
Now let’s suppose those dollars had been used for good rather than evil. That is, rather than buying imported cars, toys, and handbags, thrifty Americans would have saved their money. It’s reasonable to believe that about half of that $3 trillion would have gone into financing productive purchases here in the U.S.–new factories, power plants, office computers and the like–$1.5 trillion worth.
So what would be the payoff from all that thriftiness? A reasonable rate of return on investment, after depreciation, is roughly 7%. So $1.5 trillion in extra assets would have a return of about $100 billion a year.
That $100 billion is roughly 1% of an $11 trillion economy. Over ten years, then, complete elimination of the trade deficit might–might–have added a tenth of a percentage point to growth.
That’s a good measure of the size of the virtues of savings–roughly a tenth of a percentage point on growth. That’s 0.1 percentage points.
Let me begin with a clarification about the question that
Michael Mandel is asking here. I would start with the accounting identity that national saving equals investment plus net exports. One question that we might consider is what would happen if U.S. national saving were to rise by just the amount needed to bring net exports from their current big negative value up to zero, thereby eliminating the trade deficit but keeping the value of investment unchanged. This thought experiment would have no effect on investment and construction of factories (by definition), but would mean that we would not have to borrow or sell off assets each year to pay for the net imports. The amount by which such asset transfer would be reduced if the trade deficit were eliminated would be the full amount of the trade deficit, not one-half. The annual flow consequences of this would depend on which assets were being used to finance the trade deficit. To the extent that America is simply borrowing from foreigners to pay for the imported goods, each $100 billion reduction in imports would mean $100 billion less borrowing for that year. Using the 2% real interest rate on Treasury inflation-indexed securities, each $100 billion in lower borrowing means we will owe $2 billion less in interest every year thereafter. To the extent that the deficit is financed by selling off U.S. companies such as Unocal or Maytag to foreign bidders (as appeared likely this summer, though neither of those highly publicized deals went through), a higher rate of return for calculating the burden should be used.
Another way one might want to modify the raw numbers would be to note that for 2005, analysts are expecting a current account deficit of $800 billion for 2005, at which rate in just four more years we’ll have further doubled the burden acquired under the last ten.
Leaving aside these qualifications about the precise nature of the change we’re seeking to evaluate, let me get to the heart of what Mandel is addressing, which is whether changes in investment flows really make any difference for living standards. If we’re interested in living standards, what we care about is the level of income per person. Let b denote the fraction of GDP that goes to compensating owners of capital. For a country like the U.S., b is about 1/3. If we increased the capital stock per person by a percentage amount %ΔK, economic theory predicts that output per person Y would go up by a percentage amount given by
The basis for this prediction is similar to that used to predict the economic effects of changing energy use that I exposited here.
With the additional output that this generates, we would have the income to invest even more, and there is the possibility of a compounding effect of the original added productivity. The effect of this is fundamentally limited, however, by the fact that we’ll also be needing more and more dollars of each year’s output devoted to keeping up with such factors as depreciation and a growing work force. It turns out when you work through the math that if we were able to permanently increase the fraction s of income that’s devoted to saving, we’d succeed in increasing the capital stock per person by an amount
This equation is associated with the theory of economic growth proposed by Nobel laureate Robert Solow in the Quarterly Journal of Economics in 1956, though it really is simply the accounting implications of the calculations that I just described. Putting the two equations together, a permanent rise in the saving rate is expected to result in a permanent increase in output per person given by:
If b = 1/3, this elasticity [b/(1-b)] would be about 1/2. If the U.S. were to increase annual investment spending by $400 billion from the current $1.9 trillion, that would represent about a 20% increase in s, implying eventually 10% higher real income per U.S. resident. If one looks at the correlations across countries, one finds that countries with 20% higher values of s do indeed have on average at least 10% higher real income per person; (see for example Table 2 in “A Contribution to the Empirics of Economic Growth,” by Greg Mankiw, David Romer, and David Weil in the Quarterly Journal of Economics in 1992).
Is 10% more income per person a big deal? I would say that it is, though Mandel is certainly correct that, if we had some policy that could make even a modest change in the productivity growth rate, it could potentially have a much bigger effect over time. The problem is that I’m not sure what such a policy would be. Certainly insofar as productivity gains result from firms’ investments in new technology, the way to get those gains is through additional investment, which Pro-Growth Liberal logically sees as another reason why saving can indeed matter a great deal. In Mankiw, Romer, and Weil’s regressions, 80% of the variation across countries in output per person was explained statistically by differences in countries’ saving rates, population growth rates, and educational commitments. In a subsequent study published in the Quarterly Journal of Economics in 1995, Alwyn Young found that much of the phenomenal growth rates of several of the countries of southeast Asia could be accounted for by their high rates of capital accumulation.
Mandel is correct that we should not attempt to oversell the magnitude of the benefits that might be obtained from raising the U.S. national saving rate. But I also believe that for purposes of discussing policy options, it makes sense to focus on the variables that we can actually do something about. The U.S. budget deficit is something we could control, and I believe that we should.