Misunderestimeasurementation

Oroborous was kind enough to send this my way recently:

By Brian S. Wesbury and Bill Mulvihill

We are not sure which economic “old wives tale” is the most damaging. But right up at the top of any list is the idea that the US has a negative savings rate.

Yes, it is true, that the Bureau of Economic Analysis (BEA) says that US consumers spent more than their after-tax income in 7 out of the last 8 months and through November 2005, and had a savings of negative $39 billion.

To get these figures, the BEA adds up sources of income - wages, salaries, interest, dividends, rent, proprietor’s profits, social security, and unemployment insurance benefits. It then subtracts taxes to arrive at disposable income. The BEA then subtracts total consumption to calculate savings.

There are many reasons to discount these statistics. For example, when a car, home appliance, or computer is purchased, the entire expenditure is immediately subtracted from income, even if it is paid for over time. Spending on education also counts as consumption. But, these expenditures are investments and on a set of corporate books would be treated much differently.

While 401k’s, IRAs, and other savings plans are accounted for, capital gains on these assets or on a home do not count as income. However, taxes paid on capital gains subtract from disposable income, a downward bias.

As our population ages, a growing number of retirees spend out of savings, which also biases the statistics downwardly. In addition, the government has a difficult time separating business spending from personal spending because so many small (and large) businesses buy office supplies and construction materials at retail outlets (such as Office Depot, Staples, Home Depot and Lowes). To the extent that government counts business spending as consumption, savings will be undercounted.

To top it all off, personal income, wages and salaries can be significantly understated because income statistics are gathered from data collected by the Establishment Survey, which undercounts employment. In March 2005, for example, wages and salaries were revised upwardly by 1.8%, or $92.7 billion. If the same type of revision occurs this year, the negative savings rate will be revised away. This, by the way, is highly likely.

The best measure of household savings is calculated by the Federal Reserve in its quarterly Flow of Funds Accounts. This data shows that US households had $62.5 trillion in assets at the end of September, $11.4 trillion in liabilities and a net worth of $51.1 trillion. This is a record level and $5 trillion more than a year earlier. Of the increase, $3.3 trillion was in financial assets, suggesting that US households are one of the best savers in the world. Contrary to popular belief, the US does not have a negative savings rate.

Right off the bat, I wondered just how wide of the actual mark the Headline Savings Rate (HSR) might be. So, following time-honored journalistic tradition, I decided to generalize from personal experience. Why not? Either everyone is like I am, or they are wrong.

Besides, it avoids all that annoying research stuff, which often gets in the way of extrapolating from a single data point.

In a few brief paras, Messrs Wesbury and Mulvihill manage to raise few interesting questions, intentionally or otherwise:

Just how far off might this statistic be?

According to the BEA, after dividing what was left over after consumption by my disposable income, my HSR is just shy of 13%. However, one of the biggest components of consumption over the last year was rent. Well, in my case, mortgage, which the BEA treats just like rent -- a transparently silly notion. Depending upon how far along a homeowner is in paying off the mortgage, a greater or lesser portion of that mortgage payment is money in another form, real estate, going into the owners pocket. The HSR is completely unable to explain the existence of the single greatest store of wealth for many people: their own homes. Someone who has paid off their mortgage is in possession of a substantial asset that, according to the HSR, simply came out of nowhere. Given the rate of homeownership in this country, roughly 65%, that is a significant downward bias in the savings rate.

In my particular case, six years into a 30-year mortgage, including the contribution to principle moves my savings rate to 16%.

Aside from the transparently silly, there is the hopelessly contradictory (as in "Islam" and "tolerant"). The IRS is happy to tax investment income, but the HSR is treats that income as if it doesnt exist. I have no idea what proportion of Americans have 401k plans, stocks, or mutual funds. But giving in to the above mentioned time-honored journalistic tradition, I'll say it is 100%.

In my particular case, including reinvested income, after the attendant double taxation, my savings rate jumps to 26%.

And what about those taxes? How much do you want to bet the HSR includes only those things that show up on a W-2? That is easy to collect information, but leaves out two significant taxes that significantly detract from disposable income: sales and property taxes (see above: homeownership, rate of).

In my particular case, subtracting those taxes from disposable income moves my savings rate to 27%.

Then there is the matter of what the spending is for. Due to the ravages of time, this year my house needed a new driveway and deck. Both had deteriorated significantly, and would have detracted from the resale value of my house. Never mind leaving me vulnerable to personal injury lawsuits. If I was allowed to expense that over 5 years (IIRC, typical for businesses), then my savings rate goes to 31%

So, in the instance of one real world example, the consistent with Econ 101 savings rate is nearly three times the HSR. And while my specific numbers may be on the high end of the range -- thank goodness, for the economy would tank, otherwise -- the reasons for the significant difference are not unique. Quite the contrary, they are characteristic of an economy with widespread home ownership, as well as mutual fund/401k/IRA holdings.

Given its apparent manifest shortcomings, why does the MSM keep citing this number (see also, Male v. Female pay studies)?

Many reasons, of which lazy and stupid, while probably on the list, are not particularly near the top.

1. The MSM has operated as an oligopoly. The relative absence of competition has allowed certain "objective" measures of the economy to become entrenched as accepted wisdom. The CPI is yet another example.

2. Any given example of the MSM is going to have a relatively limited staff; hence, there is unlikely to be significant specialist knowledge at any news organization. For two examples, I doubt, say, CBS, has technical/engineering expertise anywhere near what AOG (frequently seen at BrosJudd) can bring to a problem. Similarly, on legal issues, David Cohen will put to shame anything from the MSM. Steve den Beste referred to this effortless accumulation of expertise as the "Hive Mind" (no link, but I think I have the essay if anyone is interested).

3. Reporters are often so unsurprised at numbers confirming accepted wisdom that they don't ask the obvious question: is this number consistent with its consequences? On the face of it, a household savings rate ostensibly slightly less than zero is competely unable to explain a 10% increase in household net worth over the same period. One of those numbers has to be barking mad, but uncritical acceptance of the alarmist number stands four-square in the way of asking even obvious questions.

Given its apparent manifest shortcomings, why does the BEA keep citing this number?

Dunno, although lazy and stupid would probably stand out in the lineup of usual suspects. At the very least, the systematic downward bias in the HSR should get someone's attention. You would think.

What does this have to do with Darwinism?

No one questions that the US economy is obviously capable of unplanned self-organized complexity. Equally, no one would deny that measuring even a simple element of it is fiendishly difficult. My personal example is one thing, but aggregating it over an entire economy something else altogether (ignoring for the moment entrenched silliness).

So why should self-organized complexity be prohibited to such a densely interconnected and dynamic a system as Natural History?