Social Security, Student Loans and the Paradox of Thrift

A Contradiction at the Heart of Our Economy

      We have a deep contradiction at the heart of our economy and our society. Our economy cannot grow or provide jobs for people unless most of us spend more than we can afford and unless most of us fail to save adequately for retirement. Put simply, we have a choice as a society between high unemployment and poverty in old age. Why is this so?

Why We Must Spend

      Consumer spending is a large portion of economic activity in the United States. Although there is disagreement among economists over the exact percentage, everyone understands that consumer spending is important and that if it is not robust, our economy will suffer. If consumer spending is strong, businesses become optimistic, and they hire workers. If consumer spending is weak, businesses become pessimistic and lay off workers.

     Thus, in order for our economy to be healthy, we must spend, and this season is the time when we spend the most. A great deal of advertising effort goes into persuading us to spend, and we have become used to the idea that we can use credit cards to spread the cost over several months. We run up debts during the holidays and the interest on our debts adds to the cost of the gifts that we give. Holiday giving is not the only time we spend, of course. We buy cars. We furnish our houses. We acquire electronic gadgets, and we take expensive vacations. All of these contribute to the economic health of our economy and persuade businesses to create jobs.

We are Unprepared for Retirement

       But what about our individual economic health? It is well known that most Americans are woefully unprepared for retirement. Most of us don’t save enough to build healthy nest eggs, and many of us are facing difficult times in old age. So, while our economy is healthy, many among us are not healthy economically because we do not save enough.  We could save more and spend less, but if all or even most of us did that, consumer spending would decline dramatically, and we might well face a big recession. That contradiction between individual thrift and societal well-being is called “the Paradox of Thrift,” and it tells us that if we all saved as we should, our economy would suffer. Many people would lose their jobs and become unable to save just because they and everyone else had tried to save.  So, we have to keep on spending.

Spending is Threatened by Our Aging Society

       Unfortunately, healthy consumer spending is threatened by demographic trends. Our society is getting older as the baby boomers retire, and many of them are not prepared for retirement. They don’t have enough saved. People who don’t have much money can’t spend much. So, as the baby boomers retire, we can expect consumer spending to decline. We will be able to maintain consumer spending to some degree by loosening credit requirements and allowing people to finance their purchases with credit cards even though we know perfectly well that they will probably never be able to pay their debts. However, we saw in 2008 that this is not really a good idea. How can we balance the health of our economy with the need to provide for a comfortable retirement? How can we have sufficient consumer spending without impoverishing our senior citizens or our workers?

How Can We Maintain the Spending That We Need? 

      There are a couple of things that we can do, and we must do them together. First, we can strengthen and expand Social Security into a real, national pension system that provides people with a reasonable standard of living in old age.  If we do that, our seniors will be able to live comfortably and spend money. They will not buy the things that young people buy, but they will take their grandchildren on vacations and buy new cars.

      However, expanding Social Security will require working people to save more than they are saving now, and that will have a negative effect on consumer spending. We can minimize that effect if we finance the expansion of Social Security by raising the maximum income on which Social Security taxes are paid. This will concentrate the effect at higher income levels where people already save a higher portion of their income than poorer people do.

     Second, we can reduce the interest rates on student loans. This will have the effect of reducing the sizes of the monthly payments that recent graduates have to make, and that will free up more of their money to be spent. They will be able to buy houses and furnish them. They will be able to replace their cars.  They will be able to increase their spending on holiday gifts.

We Should Act in Our Own Interest

      I am not advocating these changes for humanitarian reasons, although I could do so. I am not suggesting that we expand Social Security because old people deserve a comfortable retirement, nor am I not saying that we should reduce the interest rates on student loans because the current rates place an unfair hardship on recent graduates. I am saying that we should do these things for a purely selfish reason, which is that if we do not do them, our economy will suffer, and all of us will suffer with it.