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Saving Britain

Last year&#39s study by Oliver, Wyman & Company, on behalf of the ABI, found that half of all households need to save at least an extra 10 per cent of their income to fund a comfortable retirement. This implies an aggregate increase in savings of £27bn.

The report proposes certain initiatives to encourage savings. These initiatives are especially targeted at lowand middle-income households who are most at risk of underproviding for their retirement.

As noted in last week&#39s Money Marketing article, Mind the Gap, closing the savings gap raises some wider macroeconomic questions. A total of £27bn of increased savings means a corresponding reduction in aggregate consumption.

Concerns over the macroeconomic impact of increasing the savings ratio are not unimportant but we do not believe there is undue cause for alarm. The solutions being developed will gradually and partially close the gap rather than providing an instant £27bn increase in savings.

The academic debate going on around the macroeconomic effect of increased savings is inconclusive. However, in the case of the UK, there are several reasons to believe that the long-term effect of increased savings will be at worst neutral and at best lead to higher incomes, higher levels of consumption and better standards of living across the lifetime of each individual.

An obvious concern is that the UK does not fall into the economic trap in which Japan finds itself. But the reasons behind Japan&#39s stagnation are far deeper than low consumer expenditure. A long series of events ranging from fiscal mismanagement to poor corporate lending have led to its present situation. Indeed, low consumption is more of a symptom driven by low consumer confidence than a cause of the original problems.

As the table below shows, the UK savings ratio of 5.4 per cent has a long way to go before it begins to exceed those of its peers. Increasing saving by the extra £27bn required would still leave the savings ratio below that of Germany, France and Japan.

In the UK&#39s economic climate, increasing the savings rate over time can have a number of positive short-term benefits. By reining in short-term demand as the economy recovers from its downturn it can help to keep inflationary pressures and interest rates low.

Furthermore, like Chancellors before him, Gordon Brown has seen increasing investment as the main instrument for raising UK productivity and standards of living to European levels. Higher savings are one way this can be achieved. Indeed, in the long run, the only true way of increasing the aggregate level of investment is by increasing private individual savings.

A huge overnight increase in savings could present difficulties for the economy as it tries to invest the new savings productively. In the real world, of course, this is unlikely to happen.

The Oliver, Wyman & Company study suggested a number of policy options, none of which would completely close the gap and all of which would take effect over time rather than in a “big bang”.

This phasing-in of extra savings would allow the economy time to react and reallocate resources if required.

Furthermore, any impact on consumption will be transitory. Saving is simply a mechanism to defer consumption. The result is to smooth individual consumption over one&#39s lifetime.

As individuals draw on their savings, we will not only see that current levels of consumption are restored but on aggregate may be higher due to the productive investment of savings. So in the long run closing the savings gap could well result in consumption higher than current levels.

The greater danger is, without a doubt, leaving the savings gap unaddressed. In recent years, net savings in the US have become negative. That is, people are consuming more than they are earning. Studies by two British economists, Wynne Godley and Bill Martin, have highlighted the real worries that this is causing for the sustainability of the American economy.

In the UK, every year the savings gap is left unattended is another year in which millions of lowto middle-income households fail to save enough for a comfortable retirement. As every IFA will tell their clients, the longer you leave it, the bigger the problem.

Moreover, falling occupational pension contributions, with companies moving from defined-benefit to defined-contribution schemes, will serve only to exacerbate the gap.

Concerns over the macroeconomic impact of increasing the savings ratio are not unimportant but there are good reasons to believe there is no cause for alarm. The actual impact on the UK economy will depend upon the details of the implementation, which are currently being designed with these concerns in mind.

2001 household savings ratio

(Household savings as a percentage of household disposable income)

UK 5.4%

US 1.6%

Japan 12.5%

Germany 10.2%

France 16.4%

Source: Office of National Statistics, Bureau of Economic Analysis, Datastream

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