Wealth Gap

Why Don't Americans Save?

Ever wonder why people buy $34,000 cars on $25,000 incomes? It's not quite as crazy as you might think.

America's wealth is very unequally distributed. Whites have more of it. So do older people, more educated people, and people with higher incomes. The government homeownership policies that contributed to the housing bubble were a largely well-intentioned attempt to give poorer people access to what had been a major vehicle of capital accumulate for affluent whites.

Unfortunately, it didn't work so well; the collapse of the housing bubble hit the poorest hardest. Not the very poor--who had neither the money or the credit to buy homes--but the working poor and the working class, the folks who could scrape together just enough money and signing power to get themselves in deep trouble.

Noah Smith suggests that what we really need to do is change how the less-wealthy save: how much they save, and how they save it.

If you do the math, you discover that in the long run, income levels and initial wealth (factors 1 and 2 from above) are not the main determinants of wealth. They are dwarfed by factors 3 and 4 -- savings rates and rates of return. The most potent way to get more wealth to the poor and middle-class is to get these people to save more of their income, and to invest in assets with higher average rates of return.

As I mentioned, income redistribution helps these things a bit, but it doesn't account for the whole difference. The rich probably save more than the poor for many more reasons besides the simple fact that they're rich. In fact, being willing to save more is probably a big part of how the rich got rich in the first place. "Cheap" is an insult, but being cheap is how you get rich. If you consume everything you earn, your consumption will be higher today, but lower twenty years down the road; in our consumption-focused society, a lot of people are caught in this trap. And government can and should help them get out.


What can government do to get middle-class and poor people to save more? Higher interest rates don't do the trick -- people didn't save more in the early 80s when interest rates were stratospheric. High stock returns don't do the trick either -- in the booming 1990s, people actually saved less, seeming to prefer to "let the market do their saving for them."

Instead, the answer is to change America's culture of (not) saving. This sounds hard, but actually it is probably very doable. For years, behavioral economists such as Richard Thaler have been studying ways to "nudge" people to save more. The most famous "nudge," which has been endorsed by President Obama, is to make employee pension plans "opt-out" instead of "opt-in". But there are plenty of others. In lab experiments, just giving people information on how to save money makes them save a lot more.

This means that more financial education in public schools is a must. I'm not talking about teaching kids the Capital Asset Pricing Model. I mean what Bob Shiller calls "basic Suze Orman stuff." How to make a monthly budget. What "saving" and "borrowing" mean. How wealth builds over time. How to avoid borrowing lots of money at high interest rates (e.g. credit cards and payday loans). Etc. The new Consumer Financial Protection Bureau can help a lot with this too, by preventing companies from tricking poor people into taking out high-interest debt.

Ironically, given our policies, this probably means moving away from housing--minorities, especially, tend to have a larger share of their assets tied up in their homes than whites do--and towards stocks and bonds. It also means moving towards saving and away from spending.

Given the financial advice I regularly dole out, one would assume (correctly) that I am on board with this plan. But I think it may be more difficult than Smith suggests. There may be a reason that people with less income have less in the way of non-housing wealth.

I am talking about work from Kerwin Charles, Erik Hurst, and Nikolai Roussanov on conspicuous consumption and race. They were investigating the folk perception that blacks and hispanics spend more on visible consumption goods: cars, jewelry, houses, and so forth. This has implications for a long-standing problem that has puzzled social scientists: even when you control for things like income, blacks and hispanics have less in savings than whites do.

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Charles, Hurst and Roussanov found that it's true that blacks and hispanics spend more on highly visible consumer goods, and less on things like health and education. But before you cue up the disparaging racial remarks (or get ready to decry the racism of the paper's authors), it's important to clarify that their work does not suggest that blacks and hispanics are spendthrifts. Rather, their work suggests that members of lower-income demographics are investing a lot of their money into signalling that they are not poor.

Charles et al didn't just tot up how much members of each racial group spent. No, they did something much more clever: they broke their results down by state, and asked an interesting question: is the amount that you spend related to the average income of your racial demographic in that state? If it wasn't related, then they'd have to look for something else, like credit availability or culture, that might be driving the spending.

On the other hand, if visible consumption spending was inversely correlated with the average income of your local racial demographic--or to put it in plain English, if blacks in a state with relatively high average black incomes spent less on cars and jewelry than blacks in a state with relatively low average black incomes--then this would suggest a very different reason for the consumption. A very rational reason: communicating that you are not as poor as the average for your demographic.

And that's exactly what they found: the higher the average income of your racial group in your state, the lower the fraction of your income you devoted to highly visible status goods. More importantly, this was true for all racial groups: whites in rural and southern states, where incomes are low relative to the rest of the country, spent more of their income on visible consumption goods than whites in higher income states.

In other words, though this initially seems to be about race, it's actually about income inequality: when you've got a lot of income inequality affecting easily identifiable groups of people, you will see a shift towards highly visible consumption, and away from "investment" type activities like education.

Of course, America's historic racial divide does drive a lot of income inequality. But buying visible consumption goods is not someting that minorities do in order to prove that they're not poor; it's what everyone does when they're vulnerable to snap judgements about their income based on a few superficially visible demographic characteristics.

In short, visible consumption is used as a tool to fight discrimination--racial and otherwise. If you're a member of an identifiable demographic with low average incomes (southern, racial minority, rural) you are likely to be treated as if you are poor. That makes it harder to get everything from a taxicab to a job. The way to fight that (short of totally remaking society) is to have very visibly expensive stuff. So it may actually make economic sense for many middle class members of those demographics to divert money away from saving and into consumption and housing, while affluent white coastal types slob around in wrinkled chinos and twelve-year-old Hondas, and stuff the savings into their 401(k)s.

And even if that sort of spending shift doesn't make economic sense, it may make emotional sense. It is easier to say "What do you care about what other people think?" then to internalize it. Obviously many people manage it--these are averages, not predictions about individual behavior. But what the averages tell us is that if you're automatically perceived to be low-income, it's probably harder to divert money into non-house savings than it is if you're a member of a group that's automatically assumed to be affluent.

And while those sorts of demographic gaps are certainly not all of the story in savings behavior, they are a substantial part. Moreover, these are some of our most worrying wealth gaps, because they represent other, even deeper, fissures.

This may also explain--though I am speculating here--why America has such a terrible savings rate relative to other countries. A more compact, homogenous country has fewer visual cues to help with statistical discrimination. Perhaps you know that someone from East Germany is more likely to be poor than someone from the West, but there's no way to identify them in a glance, or necessarily even in a short conversation. So maybe there's less need for consumption signals. America, as large and diverse as it is, offers a lot of ways to make snap judgements about strangers. So a whole lot of us are engaged in combatting those judgements . . . with cash.

Obviously, I hope that everyone will ratchet back on consumption goods and take savings more seriously--especially those on lower incomes, who can least afford to be without a cushion. But I think this suggests that in some of the most important cases, it may take more than a nudge.

This article has been edited for clarity.