Thursday 25 December 2014

Young and old dealing with debt differently but it remains economy's biggest problem

Published 22/04/2014 | 02:30

Saving has always been important for the economy as a whole
Saving has always been important for the economy as a whole

I remember being introduced to saving through a large plastic hippo and some stickers in the era of SodaStreams,Transformers and ThunderCats. This plastic hippo was a money box, and like thousands of others, I saved for the fun of it. Saving even became a fad in my circle of friends. It faded, as all fads do, and now I'm trying to get my own children to save and searching for the modern equivalent of that plastic hippo. Time flies, but saving has always been important for the economy as a whole.

Saving is the pool from which productive investments are drawn, where pensions get paid from, and where the difference between what households consume and their disposable incomes get stored. Households pay their debts down out of savings.

At the level of the economy, when saving is too low, it means investable capital either has to come from abroad – which is pretty risky – or it means excellent projects just won't get funded, which hampers growth. If saving rates are too high, then not enough consumption takes place, and the economy doesn't grow as it should either. So looking at how savings actually behave in the Irish economy is vital.

In Ireland today the savings rate is about 10pc of national output. The savings rate dropped as low as 1.6pc during the construction boom, jumped up during the crash as people stopped consuming and took precautions against a more uncertain future, and is now about the level it was in 2006.

Not everyone saves in the same way as they age. Nor should they. A new report from Kevin Timoney of the ESRI shows the results of 50 months of survey data of around 800 people per survey. The survey started in January 2010.

Timoney's work builds on Petra Gerlach-Kristen's paper published by the ESRI last year which looked at household consumption and saving by older and younger households throughout the crisis. Gerlach-Kristen showed the destruction of income and wealth, particularly in assets, held back consumption and increased savings, exactly as you would expect, but her work shows a completely different reaction to the crisis.

Income and consumption increase steadily for the average household over the age of 45 from 1994 to 2010, while income and consumption for households below 45 years suffered a huge drop in the crisis. Between 2004 and 2010, real disposable income for households under 45 dropped by 14pc, real consumption including housing dropped by 25pc and excluding housing consumption dropped by 32pc. The difference between younger and older households could not be more marked. Younger households experienced a collapse a bit like a marble running off a table, while older households experienced an increase throughout the crisis. This point was made forcefully by David McWilliams in his book 'The Generation Game' in 2005.

The Central Bank's Reamonn Lydon also showed households with debt problems spent less, so the combined effects of a debt overhang in some households, combined with income drops and wealth effects from the equity in their assets vaporising, probably contributed to increased saving rates by households.

The results of Timoney's paper are striking because they look at how people of different ages actually save, and how they expect to save in the future. Now a bit of common sense tells you this should be the case.

You wouldn't expect, say, UL students to save in the same way at 50-year-old homeowners, but the variation between groups, from ages 21 to 35, from 35 to 50, and 51 years and over is really large, and has changed throughout the crisis.

I'm in the 21 to 35 bracket. Timoney's paper shows this group is saving at a much higher level than the other two groups. Almost 80pc of those surveyed save regularly or occasionally. In contrast, those from 36 to 50 and 51 years or older only save regularly around 50pc of the time. Younger households also expect to save more if they get an unexpected windfall – about 60pc of them will save any unplanned increase in their incomes compared with 45pc of older households.

In the Irish economy today younger households are doing more saving than older households.

Economic theory suggests the opposite should be true. People from 21 to 35 should be spending on housing and on children, while older households should be saving more for their retirements. What is causing this increase in younger people saving?

These households are saving for deposits for houses, and waiting until the market bottoms out. If this is true, then we should see a drop in savings rates by younger households as the housing market improves. For the 36-50 age group, Timoney's paper also shows a strong preference for debt repayment over other choices, showing this group will do anything to rid itself of debt if it can.

Timoney's paper is the type of work we need to see more of. It points policy makers exactly to where the problems in the economy are, and gives them a sense of what they might do to help these households and, crucially, exactly how much help is required. It is further evidence that the major problem within the Irish economy – debt – is still with us but experienced differently by younger and older households. Plastic hippos won't help us this time.

Stephen Kinsella is Senior Lecturer in Economics, University of Limerick.

Irish Independent

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