The Magazine

There Is No 'Paradox of Thrift'

Neither a borrower nor a spender be.

Jun 15, 2009, Vol. 14, No. 37 • By DAVID BLANKENHORN
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Frightened by tough economic times, formerly spendthrift Americans are beginning to save. But the shift is causing alarm among some economists and commentators. Prudent savers, say these writers, are exemplars of the "paradox of thrift," which holds that the practice of thrift, while seemingly wise and rational for the individual, can be harmful for society.

So it is that a Wall Street Journal headline warned: "Hard-Hit Families Finally Start Saving, Aggravating Nation's Economic Woes." A story in the New York Times said the "re-emergence of thrift as a value" presents a serious problem: "Economists call it the Paradox of Thrift." Another Times piece cautioned: "Putting away money and paying down debt may be good for one family's kitchen-table economics, but the broader economy suffers in the short term when millions of families do it." Nobel Prize- winning economist and syndicated Times columnist Paul Krugman regularly beats this drum. And a recent Newsweek cover, evoking World War II recruitment posters, featured a stern-looking Uncle Sam pointing at the reader with the patriotic appeal: "I Want YOU to Start Spending!"

In the 20th century, the paradox of thrift found its greatest champion in John Maynard Keynes. In his Treatise on Money (1930), Keynes argued that "mere abstinence is not enough by itself to build cities or drain fens." It is enterprise that builds. "If Enterprise is afoot," he explained, "wealth accumulates whatever may be happening to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing. Thus, Thrift may be the handmaiden of Enterprise. But equally she may not. And, perhaps, even usually she is not."

In 1931, in a radio address to the British people on how to fight back against the oncoming Great Depression, Keynes was more vehement about the futility of saving and the wisdom of spending. Sometimes, he said, saving one's money was "quite right," but at other times, including the present one, saving was "utterly harmful and misguided." He bluntly warned his fellow citizens: "The best guess I can make is whenever you save five shillings, you put a man out of work for a day." He concluded with an Uncle Sam-like appeal to patriotism:

Therefore, O patriotic housewives, sally out tomorrow early into the streets and go to the wonderful sales which are everywhere advertised. You will do yourselves good .  .  . [and you will] have the added joy that you are increasing employment, adding to the wealth of the country because you are setting on foot useful activities, bringing a chance and a hope to Lancashire, Yorkshire, and Belfast.

When writing for policymakers and economists, Keynes and his followers spelled out this idea in more formal terms. They posited that whenever a nation's desire to save exceeds productive investment, the result is a savings glut. The excess savings, because they are not smoothly turned into investments, are effectively quarantined from normal economic life, much as if the savers had hidden their money under the floorboards. This phenomenon in turn can help trigger a downward economic spiral, a sort of negative feedback loop in which reduced consumer spending causes greater unemployment, and greater unemployment reduces spending, and so on. In the end, everyone--including the well-meaning chap who saved his five shillings in the first place--comes out poorer.

Finally, periods of economic downturn, when people's natural concern for the future may cause them to try to save more, are precisely the periods in which savings gluts can do the most damage to society, by deepening rather than counteracting the downward turn in the business cycle.

Ever since Keynes, the proposition that thrift can be paradoxical has been widely accepted. It made its way into the best-known economics textbook of the second half of the 20th century, Economics by Paul A. Samuelson and (in later editions) William Nordhaus. Not only does it continue to influence each generation of policymakers and commentators, but among the general public, the notion is widespread that, in order to keep the economy growing, citizens have a duty, whatever else may happen, to keep on spending.

But is it true? Is there actually something paradoxical about thrift that can make it more a curse than a blessing for society? Here, in ascending level of importance, are five reasons why, in fact, there is no paradox of thrift.

5. Saved money is likely to be productive money.

It is actually possible to save too much. Anyone who is denying his children adequate food or medicine or endangering his own health in order to allocate more to savings is almost certainly saving too much.

As a group, however, Americans have never been at serious risk of oversaving. Over the past eight decades, the personal savings rate in the United States--the difference between earnings and expenditures--averaged about 7 percent. It reached about 11 percent in the early 1980s and then began a long, steep decline. By the time the nation entered the 21st century overleveraged and in debt, the personal savings rate had sunk to zero or below.

In recent months, as the economic horizon has rapidly darkened, the U.S. personal savings rate has soared. Last week the Commerce Department reported it at 5.7 percent, according to the Associated Press. By the end of the year, according to some economists, it may reach 7 or 8 percent. In other words, if they are right, by 2010 Americans may be saving at about the same rate that we've averaged since 1930.

No one would call this dangerous oversaving. On the contrary, even the current modest increase in the savings rate is good for families and the nation. The reason is simple: Savings--money diverted from consumption--are the only source of money for productive investment, and productive investment is the lifeblood of the economy.

By the same token, economists overwhelmingly agree that a high-debt, zero-saving society is one that has put itself at long-term risk. For a time, it may be possible to live the high life on borrowed money. Having other nations largely finance our ever-growing debts may allow us to kick the can down the road while continuing to shop as if there were no tomorrow.

But it's ultimately unsustainable. Over time, a thriving economy and a successful society require citizens who are willing and able to save for the future, and this fundamental fact will not change.

The "savings glut" described by Keynes and others, when the desire to save overwhelms our willingness to invest, may be a theoretical danger, but the weight of evidence suggests that it is not happening today in the United States.

The banking and finance crisis of recent months--which may already be easing--appears at least to some degree to have unnaturally frozen the flow of credit. And there appears to be a hesitancy among many investors. But no one is seriously suggesting that this problem could be solved by returning to the practice of shopping with money we don't have. After all, if that were the solution, there would never have been a crisis in the first place.

According to most analysts, the root of our financial crisis is enormously large, interlocking, and ultimately toxic structures of debt. And if piled-up consumer debt is part of the problem, running up still more consumer debt can hardly be the solution.

In fact, the solution lies in the opposite direction. An 8 or 9 percent personal savings rate in 2010, allowing households to reduce their debt and begin to live within their means, might actually ameliorate the banking crisis, insofar as it would once again position millions of Americans to become investors and wealth-builders over the long run.

More broadly, if we bracket for a moment the immediate and probably short-term failures in our banking system and take a longer view, the danger of a genuine American savings glut--savings in excess of productive investment--appears to be all but nonexistent.

Fundamentally, our economy is wide open and extremely dynamic. We value, and frequently reward, risk-taking and entrepreneurialism. Stand on any American Main Street and you can hardly throw a brick without hitting someone who is itching to start a business, make a new product, try out an idea, risk all to follow a dream. People around the world admire us (and occasionally despise us), and some of them end up coming here, for precisely these reasons. It is unlikely, under any reasonably foreseeable circumstances, that this deep-rooted American characteristic will disappear, or turn into its opposite, such that we suddenly have too many saved dollars chasing too few new challenges and new ideas. In America, saved money typically is productive money.

4. For individuals and families, it's always wise to live within your means.

Consider a 27-year-old woman from Missouri, a graduate of a community college, working as a sales representative for a big greeting card company. She is recently married. Her husband also works in corporate sales. Their annual income is $84,000. They have no children, but hope to start a family soon. And owning a home is one of their dreams.

They eat out a lot. They enjoy travel. Between them, they have five credit cards, with a balance of about $11,500. (A year ago, the unpaid balance was $9,000.) Some months, they try to pay down some of the principal, but for most of the past year, they paid only the minimum. Also, the husband still owes about $16,000 on his student loans. Sometimes, when an unexpected expense arises, his wife borrows money from her parents. Usually she pays them back, but not always. Together, the couple have about $700 in the bank.

Plainly, these two are spending too much. They have good jobs, a reasonable income, and no children, yet they are spending nearly every penny they have on short-term consumption, while slipping further into debt. If this pattern is projected even a few years into the future, they are almost surely looking at a painful financial crisis.

Then suppose the economy turns sour. Their companies are laying off workers and cutting back. The couple both still have their jobs, but they're worried.

As a result, they begin to make changes. The nice vacation they were planning--with the expenses to go on their credit cards--is now on hold. They try to eat out less, to cut back on entertainment, to be more careful with their dollars generally. They are being more responsible--but are they hurting their society by helping themselves in this way? Are they failing to consider, in the economic sphere, their patriotic duty?

It's hard to see how that could be the case. Indeed, most young couples are likely to feel much better about their chances of building a nest if they first build a nest egg. Once people begin to live within their means, moreover, all kinds of productive and pro-social things are likely to happen.

First and foremost, they become richer. That is the purpose of thrift. Not coincidentally, the most beloved and frequently quoted book on thrift in the history of the world, written by Benjamin Franklin, is entitled The Way to Wealth. It's almost a mathematical certainty that if people practice thrift over time--and avoid getting struck by lightning or run over by a truck--they will get richer. In all likelihood, they will get significantly richer.

Second, such savers are actually likely to spend more than people mired in debt. Couples who practice thrift and build wealth over time have more assets and savings, which in turn become productive investments, which in turn promote economic growth and development. Such thrifty couples also tend to pay more taxes. This whole dynamic is good for families and for their society. In fact, if the goal is more stimulative spending, thrift is the main way to get there.

So Americans who are now taking steps to get their financial house in order are not the problem for a troubled economy. They are the solution. No one should chastise them on the grounds that society paradoxically benefits from their overindebtedness. On the contrary, everyone should cheer their newfound thrift and hope that living within one's means becomes prevalent.

3. Governments, not individuals or families, are responsible for any deficit spending needed to moderate economic downturns.

It is true that a sudden drop in consumer spending--that is, in the demand for goods and services--can lead to unemployment, worsening an economic downturn. And in this situation, wise policymakers may wish to engage in deficit spending in order to stimulate demand, boost employment, and generally moderate the effects of the downturn. But this isn't a paradox.

Neoclassical economic theory has long taught that, in a downturn, government may properly engage in deficit spending, just as, in boom years, a wise government builds up a surplus. Keynes himself contributed to this idea. One happy result of this economic model is a balanced budget over the course of the business cycle. Another is a moderating of highs and lows. Just as calculated doses of fiscal restraint help keep the economy from overheating during upturns, so calculated doses of fiscal excess help moderate the effects and duration of downturns.

One can only wish that the Bush administration had respected these norms, instead of blithely running huge budget deficits throughout the recent go-go years. And one can only pray that now, as we confront the worst economic downturn in decades, the far larger deficits planned by the Obama administration are the right amount of federal deficit spending.

But whatever else may be true of deficit spending during downturns, the job must necessarily fall to governments. It makes no sense, from either the individual's or the society's point of view, to urge already over-indebted citizens and families to do anything other than start living within their means, so as to begin building wealth, instead of only consuming and borrowing.

Furthermore, it is far more efficient for the government to borrow than the individual. The U.S. government can borrow money to cover its deficit spending at an interest rate of 2 or 3 percent--a fraction of the 20 percent or more that families pay on credit card debt.

Then, there is what the economist Mancur Olson called the logic of collective action. There are some goals which, even when favored by all as individuals, cannot be achieved through individual action. For example, if one shopkeeper in a big, dirty city stops throwing his garbage into the street, he can have only a slight impact on the overall problem. And if he pays for private garbage removal, his costs will go up while his neighbors' costs remain constant, a development that could ultimately threaten his livelihood. The only real solution is for all the shopkeepers at once to change their behavior. There are many other illustrations of the logic of collective action, and deficit spending to stimulate the economy is one of them.

If, in the spirit of Keynes's famous appeal, a patriotic housewife sallies forth to serve her country by maxing out another credit card, she is like the shopkeeper. Her splurge will hardly affect total consumer spending, though it will make her and her family worse off. Which is why today's patriotic but intelligent housewife will instead sally over to a savings bank or credit union and make a deposit--an action that will almost certainly make her and her family better off and, by helping her move from dependent debtor to independent saver and investor, be good for society.

For these reasons, priming the economic pump in the short term must be done collectively, through the actions of government, instead of individually, through the private overspending of citizens and households. This concept is completely consistent with the thrift ethic, and there is nothing paradoxical about it.

2. Assuming that there is a paradox of thrift encourages waste.

The story is told that Keynes, in a fancy washroom at the Mayflower Hotel in Washington in 1934, instead of taking a single towel to dry his hands, dramatically pushed the entire pile of clean towels to the floor and crumpled them, explaining to his listeners that this way of using towels would do more to reduce unemployment and stimulate the economy than using a single towel.

The story may be apocryphal, but it captures the essence of the alleged paradox of thrift. In this view, it is "Enterprise" that generates wealth--regardless, as Keynes put it, of "whatever may be happening to Thrift." Accordingly, if tossing clean towels onto a dirty floor will generate a bit more "Enterprise" among underemployed hotel workers, then by all means start tossing, and thrift be damned, since it is inactivity that constitutes the ultimate danger. The values traditionally associated with thrift--carefulness, conservation--become a sideshow at best and do harm at worst.

At the center of this argument is the unethical and finally counterproductive encouragement of waste. A great weakness not only of the critique of thrift, but also of much economic analysis, is the dubious claim that every dollar spent on economic "Enterprise" is the equivalent of every other dollar spent on it.

But there is no such equivalence. A dollar spent on bottled water is clearly not as good--not as productive, as wise, as helpful to society--as a dollar spent on a tap water purifier. A dollar spent on a lottery ticket is not as good as a dollar spent on a DVD. A dollar spent on junk food is not as good as a dollar spent on healthy food. And, no, a dollar spent on cleaning needlessly dirtied hotel towels is not as good as a dollar spent on, say, improving service in the hotel restaurant.

This fundamental misconception--the idea that buying stuff is buying stuff is buying stuff, and that all of it is equally valuable to the economy--is harmful wherever it finds expression, but it is particularly harmful in the United States, where we are already dangerously in thrall to the idea that vast amounts of consumption are necessary and good.

Especially in the United States, we need to make more, and better, distinctions about how we spend our money. We are arguably the most wasteful society on the planet. On the one hand, many of us buy amazing amounts of stuff we don't need and that fails to enrich our lives. On the other hand, there are numerous domains of American life--transportation, health care, education, leisure time, and others--that cry out for more, and more prudent, expenditures.

1. Properly understood, "thrift" means the ethic and practice of wise use.

If Keynes had merely insisted that there is a "paradox of saving," that would have been an interesting proposition. But Keynes chose to call it a paradox of thrift. That is a provocation, for "thrift" is a larger and more culturally consequential idea than "saving."

Keynes apparently didn't know this. In A Treatise on Money, he criticized "that voluntary abstinence of individuals from the immediate enjoyment of consumption, which we call Thrift." And then, remember, he insisted "it should be obvious that mere abstinence is not enough by itself to build cities or drain fens."

For Keynes, and countless others who have admired and followed him, thrift is abstinence, plain and simple. It's a wholly negative concept--it means not doing something (not enjoying the goods of consumption). It connotes passivity, quietude, voluntary withdrawal. That's why Keynes could contrast "Thrift," which for him means inactivity, with "Enterprise," which for him means activity.

But the root of "thrift" is "thrive," and a thrifty person is one who thrives.

Thrift connotes growing, flourishing, spreading out. A commonly repeated maxim from thrift's heyday as an American public value is that thrift makes two blades of grass grow where only one grew before. There are plants that are commonly called "thrift." The celebrated 1911 edition of the Encyclopaedia Britannica--the very edition that Keynes would have used in the 1920s--thus explains that "there are several species of plants, such as the sea-pink, Armeria maritima, or March rosemary (Statice) which from their vigorous growth are often termed 'thrift.' "

Thrift connotes industry, hard work, prosperity. The goal of thrift is to gain and enjoy the good things of life. Says the 16th-century poet John Lyly: "Thy heart's thirst is satisfied with thy hand's thrift." The great apostle of thrift Benjamin Franklin says: "Be industrious and frugal, and you will be rich." When Franklin similarly advises that "Industry need not wish," he is offering a strategy for getting one's wishes: Be industrious. That strategy, he tells us, "consists very much in Thrift." Franklin openly states that "wealth is not his that has it, but his that enjoys it."

Thrift connotes abundance. Thrifty people, as we've seen, tend to earn and spend much more than thriftless people. Says the 16th-century poet and courtier Sir Philip Sidney: "Thrift is the fuel of magnificence."

The thrift ethic is a secular expression of the religious principle of stewardship. The main idea is that we are not the owners of our wealth, but rather the trustees, who are therefore ethically obligated to use our wealth wisely and carefully, for our benefit and for the benefit of others. The Puritan divine Cotton Mather, who strongly influenced Franklin, writes in Essays to Do Good, published in 1710: "This may be said of all our estates: what God gives us, is not given for ourselves, but, 'for the Lord.' " A quarter-century later, Franklin, in Poor Richard's Almanac, omits the theology and puts it this way: "The noblest question in the world is What good may I do in it?"

Thrift connotes saving, carefulness in spending, sustainability, and conservation. While such capacities do not define thrift, they are integral to the larger concept of wise use. Careful spending, for example, as we learn from several old writers, is "the handmaiden of generosity." Franklin constantly emphasizes the importance of frugality. For many decades during the 20th century, U.S. and British mutual savings banks gave away to their depositors small metal "Thrift Banks" (to save coins in) and pamphlet-style "Books of Thrift" (full of tips for Mom and Dad about household budgeting). A character called "Uncle Thrift," the star of an American children's book published in 1923, raps: We will be a thrifty nation, / When we all learn conservation.

Put the pieces together, and the concept of thrift turns out to be a sophisticated call for the ethics and practice of wise use. Thrift is the art of making the wisest use of all that we have--time, money, possessions, our health, and our society's natural resources--to promote both our own flourishing and the social good. The concepts most contrary to thrift are idleness and waste.

As the countless American and British advocates of thrift over the past several centuries knew, the notions of "mere abstinence" and "inactivity" can't remotely sum up the thrift ethic. When it comes to understanding what thrift is, Keynes and company are not even close. Indeed, it is only by misconceiving thrift that they have been able to foist a pernicious concept on the public mind.

To most people, the phrase "paradox of thrift" means that thrift can be a bad thing. The very existence of the phrase invites us to believe that personal restraint can be harmful and personal irresponsibility can be socially beneficial, that wastefulness is not so bad after all, and that what appears to be wise for me and my family can actually hurt society. It is past time to jettison such bankrupt thoughts and put the "paradox of thrift" out of its misery once and for all.

David Blankenhorn is president of the Institute for American Values and a co-editor of Franklin's Thrift: The Lost History of an American Virtue.