Time preference, economic crisis and social decline
24 June 2009
SUGGESTED
Tax and Fiscal Policy
Economic Theory
Economic Theory
The last decade has been marked by a combination of low savings rates and high debt levels in both the USA and Britain. Indeed in 2005, the savings rate in the US reached zero, while 13 million adults in the UK – more than 1 in 4 – have no savings or investments.
The lack of savings, together with the readiness to take on debt, suggests that a high proportion of the population has a high time preference. In other words, the present is valued far more highly than the future.
Arguably the current financial crisis cannot be divorced from the short-term, “hand to mouth” culture that has come to dominate the USA and the UK. The widespread unwillingness to defer material gratification contributed to the debt bubble that precipitated the crash.
But the negative consequences do not end there. People with no savings are also more likely to have to rely on welfare-state safety nets when they lose their job or develop a health problem. They will also tend to be more reliant on state handouts in old age and may therefore vote for socialist political parties that promise to increase such benefits. There is also a strong association between high time preferences and criminality.
While it may be tempting to blame “cultural decline” for the phenomenon, the absence of saving in countries such as the UK may in reality be a rational response to artificial incentives created by government policy.
It is perhaps not that low saving causes welfare dependence but the prospect of welfare that causes low saving. Benefit claimants with more than £6,000 may face steep deductions in means-tested payments. If they have over £16,000 they may receive nothing. And when they reach old age, the availability of means-tested pension credits means low to middle income savers will be barely better off than their spendthrift contemporaries.
Another issue is long-term residential care for elderly. While savers will lose their assets, including their home, non-savers on state benefits will generally receive care free of charge – this is a tricky issue but, at the very least, those who do not save should not be able to expect a guarantee of the same standard of provision as those who pay for themselves.
All in all, the incentives for deferring gratification and saving are very weak. This problem should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.
The lack of savings, together with the readiness to take on debt, suggests that a high proportion of the population has a high time preference. In other words, the present is valued far more highly than the future.
Arguably the current financial crisis cannot be divorced from the short-term, “hand to mouth” culture that has come to dominate the USA and the UK. The widespread unwillingness to defer material gratification contributed to the debt bubble that precipitated the crash.
But the negative consequences do not end there. People with no savings are also more likely to have to rely on welfare-state safety nets when they lose their job or develop a health problem. They will also tend to be more reliant on state handouts in old age and may therefore vote for socialist political parties that promise to increase such benefits. There is also a strong association between high time preferences and criminality.
While it may be tempting to blame “cultural decline” for the phenomenon, the absence of saving in countries such as the UK may in reality be a rational response to artificial incentives created by government policy.
It is perhaps not that low saving causes welfare dependence but the prospect of welfare that causes low saving. Benefit claimants with more than £6,000 may face steep deductions in means-tested payments. If they have over £16,000 they may receive nothing. And when they reach old age, the availability of means-tested pension credits means low to middle income savers will be barely better off than their spendthrift contemporaries.
Another issue is long-term residential care for elderly. While savers will lose their assets, including their home, non-savers on state benefits will generally receive care free of charge – this is a tricky issue but, at the very least, those who do not save should not be able to expect a guarantee of the same standard of provision as those who pay for themselves.
All in all, the incentives for deferring gratification and saving are very weak. This problem should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.
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The problem with reform is that whilst changes are urgent, their impact will not be felt for decades. Unfortunately the pain will be immediate in terms of reduced government expenditure. The issue, therefore, is not so much of system design, but how to change the cultural and political landscape to make reform tenable. In this regard it will be interesting to see whether anyone still takes Gordon Brown’s scare stories of ‘Tory cuts’ seriously over the next year. The Tories need to hold firm and win the next election, win a mandate to question the role and extent of the state: it looks like Brown in setting up the debate for them, but will they accept the challenge?
The problem with reform is that whilst changes are urgent, their impact will not be felt for decades. Unfortunately the pain will be immediate in terms of reduced government expenditure. The issue, therefore, is not so much of system design, but how to change the cultural and political landscape to make reform tenable. In this regard it will be interesting to see whether anyone still takes Gordon Brown’s scare stories of ‘Tory cuts’ seriously over the next year. The Tories need to hold firm and win the next election, win a mandate to question the role and extent of the state: it looks like Brown in setting up the debate for them, but will they accept the challenge?