This article was received from Project Syndicate, an international not-for-profit association of newspapers dedicated to hosting a global debate on the key issues shaping our world
People are fascinated by wealth. They enjoy watching the wealthy, savouring the thought of their fine homes, luxurious vacations, fancy cars, and gourmet dining. But if you infer from this that people spend a lot of time planning the lifetime accumulation of their own wealth, you would be wrong.
Most people do not seem to think very hard about how much to save from their income, or about how big the differences in their wealth could be in their later years if they just adjusted their saving rate today. Most people just pay off their mortgage, make the mandatory contributions to their state or private pension (if they have one), and keep some money for short-run contingencies. That’s about it.
The economist Frank Ramsey, in a famous article published in 1928, said that people have a “weakness of the imagination” about how their actions today affect their own future. He said that if people thought about it correctly, they might well conclude that they should save half their income. That way, the accumulated wealth might make them very happy in their later years. But, mostly, they don’t even think about that possibility.
Richard Thaler, a contemporary economist, spoke in 1980 of an “endowment effect.” Even though people may admire other things, they act as if they are mostly happy enough with whatever they already have, and lack the will to consider real change.
One of the biggest challenges governments face is humans’ apathy about future saving. Thoughtful leaders recognize that the problem is there and tangible, not to be ignored. Yet it is hard to fit solutions into either a traditional liberal or traditional conservative political philosophy.
Since 1955, Singapore has taken a direct approach: a compulsory national saving plan, which generates very high saving rates. The contribution rate for the Central Provident Fund is now 34.5% for people with higher incomes.
The United States has no compulsory saving plan, and it has an abysmally low – in fact, negative – personal saving rate. But the government is loath to consider a mandatory saving plan. Instead, it is taking steps to overcome the individual inertia that inhibits saving.
The US Pension Protection Act of 2006 encourages employers to enroll employees automatically in a personal saving plan for old age. This differs fundamentally from Singapore’s scheme, since employers are not required to do so, and, while enrolled employees’ paychecks are deducted without their consent, they can drop out of the plan at their own request. New Zealand’s recent “KiwiSaver” plan and the United Kingdom’s Pensions Act of 2007 are similarly based on automatic enrollment for employees with free opt-out provisions.
Nevertheless, according to Brigitte Madrian of Harvard University, automatic enrollment in savings plans is critically important, even if the employee is completely free to drop out. If employers tell their new employees that a pension saving plan is available, and even promise to match employees’ contributions, a significant fraction of employees still will not participate.
But if employers actually enroll their employees automatically in the plan, telling them that they can drop out at any time simply by notifying the employer, a large majority of employees will just accept the plan. Moreover, it appears that whatever contribution rate the employer chooses tends to be accepted passively by the employee, as does whatever investment allocation (between stocks and bonds, for example) is established.
The research of Madrian and her colleagues suggests that the new pension plans will improve saving in the countries that adopt them. Maybe these countries could do even better by adopting a compulsory saving plan, but they are not about to do so. So, although they won’t succeed in raising saving on the scale that Singapore has, they can make real progress.
The best reason not to make savings plans compulsory is that different people face very different circumstances that only they know about. Some people love their work, and never want to retire; for them, saving is less important. Some people want to spend a lot now on education, or psychotherapy, or whatever else is important to them now, and so want to postpone saving until later.
The fundamental problem is that while some people postpone saving for sensible reasons, and will resume saving later, many others fail to save for no good reason, and are unlikely to make up for it later.
A government saving plan that is based on automatic, though not compulsory, enrollment has the ability to deal with this problem, if only imperfectly. Automatic enrollment creates a saving plan that is sensible for the typical person. People who are not paying attention and are just not active will simply remain in the plan, while those who want badly enough to opt out can do so by writing a letter.
These saving plans show that there are methods other than outright compulsion to overcome human inertia. One hopes that, in the future, such plans will be adopted on a large enough scale that we can devise a variety of new programs that serve both inertial and active individuals well.
