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Paul Solman Breaks Down The ‘Paradox of Thrift’

April 15, 2009 at 6:20 PM EST
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During the economic downturn, the American savings rate is rising fast, with some unexpected consequences. Paul Solman examines how the economy might suffer when thrifty consumers decide to save their money instead of spending it.
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PAUL SOLMAN, correspondent: The American savings rate is rising fast, from an abysmal near-zero or below just a few years ago, up past 4 percent in January and February. Well, it’s about time, you might think.

And yet, by definition, saving means not spending, and spending is what we supposedly need right now, need desperately. So to save or not to save? That is the question.

It’s a debate that last raged during the Great Depression, when the English economist John Maynard Keynes coined a phrase again in vogue, “the paradox of thrift.”

“But what does it mean?” we asked one of our favorite living English economists, MIT’s Simon Johnson.

SIMON JOHNSON, MIT Sloan School of Management: Paradox of thrift is the idea that you try — everyone tries to increase their savings, so desired savings goes up, thrift being savings, but the act of trying to save pulls down the entire economy, gives you a big recession or maybe even a depression, and total savings don’t go up. Maybe they even go down. So everyone trying to save leads to a big slowdown and less savings. That’s a paradox.

A 'very old paradox'

PAUL SOLMAN: As it happens, a very old paradox. Back in the 1700s, at the dawn of the market system, when Handel was writing this music for England's King George I, Bernard Mandeville was scandalizing London with this satire in verse, "The Grumbling Hive."

The poem, a fable about bees, was meant as a diatribe against virtue and, especially, saving.

Once upon a time, a bee hive hummed, Mandeville wrote, by splurging, borrowing, cheating.

POETRY READER: "Every part was full of vice, yet the whole mass a paradise."

PAUL SOLMAN: Mandeville's point: the hive prospered not despite the vice, but because of it.

Now, at this very moment in English history, the economy of Mandeville's London was being visually mocked by English artist William Hogarth. So, to continue, with Hogarth's pictures and Mandeville's words, the bees, when they spent on...

POETRY READER: ... luxury, employ'd a million of the poor. Envy it self and vanity were ministers of industry.

PAUL SOLMAN: In other words, keeping up with the Joneses made everyone better off. But what if both we and the Joneses decide to cut back?

SIMON JOHNSON: We employ a lot of people through the things we buy. And we have them come, you know, clean our cars or we ask them to cook meals for us in a restaurant rather than cooking at home. And that economy, those interactions, that market is all about going out and spending.

If you decide to stay home and not spend one weekend, that's totally fine. The movie industry will probably hardly notice. But if everybody decides that movies are an unbearable luxury or even something not virtuous, that would be even worse. Then the movie industry would collapse.

Saving instead of spending

PAUL SOLMAN: If everybody saves, that is. But in the 1700s, savings was a virtue.

BEN FRANKLIN RE-ENACTOR: If you would be wealthy, think of saving more than getting.

PAUL SOLMAN: I once lunched with a Ben Franklin re-enactor who indulged me with one of the 1700s' most famous sound bites.

BEN FRANKLIN RE-ENACTOR: A penny saved is a penny earned.

PAUL SOLMAN: But enough living history. Let's return to what TV folks actually call B-roll, the video that covers narration. Mandeville's bees thrived as spendthrifts and by neglecting the words of the most famous English bard, "Neither a borrower nor a lender be."

Thrived by borrowing and spending, that is, until Ben Franklin's so-called "Protestant ethic" came to infect the hive. Imagine that Mandeville's bees are downshifting to thrift, beginning, ever so virtuously, to...

POETRY READER: ... sell stately horses by whole sets; and country houses to pay debts. Vain cost is shunn'd as much as fraud; they have no forces kept abroad.

PAUL SOLMAN: In other words, the bees were saving instead of borrowing and spending, just what some, like pension expert Dallas Salisbury, advocate now.

DALLAS SALISBURY, Employee Benefit Research Institute: Saving aggressively is probably at the individual level and the household level more clearly important and necessary than at any time in the last several decades.

Saving exacerbating the downturn

PAUL SOLMAN: But doesn't saving aggressively aggravate the downturn? As the savings rate climbed in the last quarter of 2008, the economy shrank by 6 percent. If we'd return to the average savings rate that prevailed back in the 1970s, 10 percent, the economy would have shrunk by double digits, making it an official depression.

This is just what happened to the busy bees in Mandeville's satire. The newfound thrift of the once-profligate arthropods brought the bees to their knees. And...

POETRY READER: ... multitudes, that lived on them, were daily forc'd to do the same. In vain to other trades they'd fly. The price of land, and houses falls. Artificers are not employ'd.

PAUL SOLMAN: The point of the fable: Saving created the kind of vicious spiral we're seeing today. So, in the end, are people saving too aggressively? Dallas Salisbury's still pushing thrift, paradox or no.

DALLAS SALISBURY: You'd better take care of your own situation. You'd better focus on you. You'd better be more concerned about your family's financial situation and not be doing things that are somehow maybe going to be terrible for you even if they're good for the country.

Some people must cut back

PAUL SOLMAN: As personal finance advice, even Simon Johnson doesn't really disagree.

SIMON JOHNSON: Some people have too much debt, and some people have to cut back, particularly because it's becoming harder and harder to roll over your debt. Credit card debt for many people has become more expensive.

Now, there are other people in the economy who don't face those kinds of constraints. Don't panic. And don't think you've got to pay off all your debts. That would not be appropriate in these circumstances.

PAUL SOLMAN: Because it would make things worse, warned Bernard Mandeville and then John Maynard Keynes, who cited Mandeville in his arguments of the 1930s, fearing the consequences of a sudden surge in saving. It's the same thing some people worry about today: the reappearance of the paradox of thrift.