Economic View: Building a Nation of Savers
By DANIEL GROSS
Published: December 19, 2004
AMERICANS seem to hate saving. In October, the nation's households saved just 0.2 percent of their income. And despite the tax advantages conferred by 401(k)'s, individual retirement accounts and other savings vehicles, most people simply refuse to stash much money in them. As of 2001, the most recent data available, only 8.4 percent of 401(k) investors made the maximum contributions, according to Alicia H. Munnell, director of the Center for Retirement Research at Boston College.
Cultural critics have bruited a host of theories to explain our aversion to thrift: Americans are hoggish consumers. Like children, we live for today and don't worry about the future. Our popular culture and our economy encourage consumption.
But economists have been more perplexed. After all, the tax advantages and employee match of 401(k)'s - free money! - should appeal to any rational person.
Well, it could be that Americans' failure to save is caused by mechanics, not morals. At least that is one conclusion of a recent paper by four economists: David Laibson and James J. Choi of Harvard and Brigitte C. Madrian and Andrew Metrick of the University of Pennsylvania.
The scholars examined what happened at four companies that switched the way they pitched 401(k)'s to employees. When employees were offered the option of signing up for a 401(k) upon hiring, participation rates after six months ranged from 25 percent to 43 percent. Not bad. But when the same companies instituted default enrollment - people were automatically enrolled in the plan when hired but could opt out - participation rates after six months were 86 to 90 percent. In other words, changing the position of the on-off switch essentially doubled the rate.
At a different company, when employees were simply asked to make a decision about whether to participate - yes or no - within 30 days, the rate of enrollment rose to 70 percent from 30 percent.
"This gives the lie to the mythology that the American household doesn't want to save," Professor Laibson said. "Whatever our propensities to save may be, they can easily be changed by changing the institutions in which we make choices."
What accounts for these vast differences? Well, people have to invest time and effort to opt out - or in - to a program. (But, really, how much psychic energy must one muster to check off a box?) "You can call it laziness, or you can also call it busyness. But there are an awful lot of other things to compete with your time," said Christopher D. Carroll, a professor of economics at Johns Hopkins University. As a result, in many situations, he said, "whatever the default is, an awful lot of people will go with it."
A default can also be a sort of endorsement. Employees see the forms that are presented to them by authority figures and then infer that someone with more expertise has concluded that the default - whether to save, or not to save - is a good idea.
Beyond simple inertia and deference, opting in to a 401(k) also sets off a series of complicated decisions - about investment allocation and long-term planning. Complexity turns people off.
"It's almost like you have to be a financial expert to wade through it," said Bill Gale, a senior fellow at the Brookings Institution who studies savings.
At root, then, the researchers found, the choice of whether to save comes down more to psychology than to economics. Their approach is squarely in the growing field of behavioral economics, which is gingerly stepping away from the economists' orthodoxy that humans are eternally rational, relentlessly profit-seeking machines. In this schema, our consuming selves are constantly at war with our saving selves.
"You know you'd be happier tomorrow not to put the extra purchase on the credit card, but you don't have a way to prevent yourself from charging it," said James M. Poterba, professor of economics at the Massachusetts Institute of Technology. "These findings suggest that there's a lot of psychology here that economists might not fully understand."
Indeed, Richard H. Thaler, the Nobel winner and dean of the behavioral economics field, has investigated this phenomenon. Professor Thaler, of the University of Chicago, and Shlomo Ben Artzi of the University of California, Los Angeles, devised and tested a program, called Save More Tomorrow, under which employees could opt into a program that automatically increased their savings rate over time. The results also pointed to higher levels of savings.
PROFESSOR LAIBSON suggests other possible uses of default mechanisms to increase national savings. For example, what if income tax rebates were automatically channeled into individual retirement accounts, unless people chose to opt out?
So even if the bad news is that we don't save enough, even with all the vehicles and tax breaks, there's still some good news. To increase savings, we don't have to engineer a fundamental transformation of the American character. Instead, we may just have to tweak the institutional levers that have the effect of channeling cash in different directions.
As Professor Laibson said: "People will save if it's on the path of least resistance."
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