Questions in Behavioural Economics -  Saving More for Tomorrow

Joe Murdy writes on this question - Why do so many people fail to save for their future?

Savings are a key decision in our economy; a possible backbone for strong investment, innovation and economic growth. High savings allow banks to finance lending, increasing business spending, productivity and therefore provide prosperity in the long-term. From an open-economy perspective, greater saving would mean that less domestic investment would be financed by capital flows from abroad; a smaller capital inflow pushes the trade balance from deficit toward surplus.

Furthermore, personal welfare can be improved in terms of the accumulation of wealth in the long-term, providing a stable foundation for a sound retirement, this goal is especially important because of the state pension fund will come under serious strain as the population ages. Saving is also a low risk way to become better-off. With the impact of compound interest; which if I invested £10,000 in the stock market (which has an average increase of 7%) I would have a nominal value of £250,000 in the bank. So, with these are appealing reasons to save, it is hard to believe that 55% of people in the UK have no financial plans for their future and the average US savings rate is 0%.

Modigilani’s savings theory, the life-cycle model, suggests that over a life-time consumption rose at a constant level, but income is low in early and late life, and higher in middle-age. The consumer is believed to borrow or live off endowments in the early years, save and pay off debt in mid life and then live off savings in retirement. This model makes the assumption that having determined the optimal lifetime consumption path, households have sufficient willpower to save and consume as they had planned. If instead, consumers submit to the temptation of spending now and worrying about retirement later, which is a common trait amongst our society, they might not save enough. Of course, no economic model is intended to be taken literally, and predictions are hard to make given all the uncertainties about future rates of return, income flows, retirement plans, health, and so forth. As saving is not an optimal decision, people tend not to prioritise saving in front of other financial decisions, meaning that decisions made on how much to save are not rational, as it is not their primary focus.

Classical economics teaches us that saving leads to a direct accumulation of capital. In China saving was made to become the priority with advertising, and patriotism, encouraging people to save to help their country. Saving fast became optimal, which encouraged rational calculations and high saving. Saving in China equates to 20% of GDP, which has helped the economy develop into one of the fastest growing economies, with one of the largest rates of capital investment, providing a platform for long-term growth.

Moreover, in societies like our own we have a social prejudice against people who begin saving young, unfoundedly so, as saving for the future is actually the rational and sensible action to take. But this comes from our belief that the short-term benefit that comes from consumption is in fact far greater than the long-term benefits of saving. Economist Richard Thaler proposed the “save more tomorrow” scheme. This program is designed so that people commit in advance to putting a portion of their future salary increases into a retirement savings account. When a worker signs up, he or she makes no sacrifice of lower consumption today but, instead, commits to reducing consumption growth in the future, so there is no short-term cost to saving.

Finally, I believe savings are determined by our behaviour, concerns about whether the long-term benefit is greater than the cost of forgoing the immediate consumption and also the lack of rationality in making savings decisions. I am a firm believer of removing the short-term costs with the “Save More Tomorrow” scheme; to try and remove the psychological difficulty of forgoing spending for a visualisation of future benefit you do not know exists.