The Case for "Soft Paternalism" (At Least for Saving)

Back in early April, The Economist had this article about the rise of what they call "soft paternalism." The idea behind "soft paternalism" is that the state uses rewards and incentives to moderate or temper behavior instead of punishments and criminal sanctions. The Economist is of the opinion that "soft paternalism" is much more dangerous than "hard paternalism" because it's so much more subtle and psychologically manipulative.

I disagree. I don't know what economists that they're consulting, but the alternative reading that I've done on the subject suggests the complete opposite in the newest and most popular form of soft paternalism - automatic enrollment in 401(k)'s. At the moment, you have to fill out a small mountain of paperwork to enroll in a 401(k) program and the prospect of voluntarily stuffing money into a savings account you won't see for years (or decades) is rather depressing, especially if you noticed a particularly spiffy tie (guys) or a hot pair of shoes (girls) on the way to work.

Ugh. What a comment. I am becoming too Swamp-esque. Anyway, moving on.

So the incentives for putting money into a 401(k) savings account ain't too spectacular, at least in the short run. In the long run, they're spectacular, because you'll probably get a better return on your investments (unless you put all your money into an Enron or Worldcom and don't diversify) than you could probably get anywhere else. Not to mention that you'll be helping the gargantuan current-account deficit by allowing companies/the government to borrow money from domestic sources rather than mucking about in China for investors.

For those of you who are patriotic and have no earthly idea what I'm talking about, think of it this way. Companies and governments (especially governments) borrow money when they don't have enough of it themselves. To, say, buy a new office building (if you're a company) or go to war and are too timid cowardly to raise taxes (if you're a government). Now, companies or governments can borrow money from domestic investors or foreign ones. If they have to go abroad, all that money that they have to pay in interest payments gets sucked out of the economy and becomes part of the current-account deficit that you've probably all heard of. Just for reference, our current-account deficit is just a shade over $800 billion, or nearly 7% of GDP.

Think of the current-account deficit like this. Companies and governments can only borrow as much money is being saved by banks or individuals. Say there's $100 that can be borrowed in the U.S. from domestic sources and the combined total of corporate and government borrowing is $120. Companies and governments (especially governments) aren't going to halt their spending plans just because they can't borrow from Americans - they'll look offshore if they have to. That $20 that is borrowed from foreign sources is our current-account deficit.

Companies (and particularly governments) would much prefer to borrow from domestic sources, because then they don't have to go through the bothersome process of converting their currency (and paying the fee that comes from massive transactions on this scale) to finance the buying; governments would much rather keep their bucks in the national fold.

Now that my kinda-sorta-tangential explanation is over, I can get back to why automatic saving in 401(k)'s kicks ass. When you put your money in a 401(k), it doesn't just sit there in a black box and mysteriously accumulate. No sir - that money is working hard, and not just for you. 401(k)'s put money in stocks, bonds, etc. The borrowers of that money - be it the government to buy votes expand entitlement programs for the elderly or companies through the purchase of stock - will use those funds to finance their operations. And they'll be doing it by raising money from domestic sources - namely, you, the chap (or chapette) whose employer had the foresight to automatically enroll you in a 401(k). They win (they get the cash), you win (you get a return on your investment better than the 0.15% that your checking account is giving you), and the American people win (lower current-account deficit, more money circulating about here at home).

So why does the government need to step in anyway? If more people knew about this, then clearly they'd enroll, because it's in their long-run self-interest.

Eh heh...and here we come across one of the biggest problems of capitalism. Theoretically, of course, it is in everyone's long-run self-interest to save more money for emergencies or retirement. But given that the national savings rate has been consistently negative for a while now (sure, it doesn't include capital gains, but even controlling for that there's no way it's at the relatively safe concensus of 10% of earnings) it's clear that it's going to take a bit of an extra push to get people to save their money for the future. Most people just don't always actively think about their long-run self-interest; that is, expend the extra effort/restraint needed to do so. Automatic enrollment can provide that push.

Since when is it the government's job to make sure that people save money, anyway? Why reward laziness by having the government nanny people around? This is the question that The Economist asks.

Here's my answer - sure, it's not the government's job to have a safety net that breeds a culture of laziness and complacency. I would never suggest something like that. However, in this respect, it is warranted. Not because of some abstract idea of government as eternal protector, but because the government has an interest in keeping as many people off its poverty rolls as it can. Surely no one begrudges the government the right to try and make everyone better off so that it doesn't have as many dependents clamoring for government handouts?

By protecting employers who start an automatic enrollment plan (with the voluntary opt-out), the government boost participation in these programs. By helping the individual make one choice, the government gives a more affluent person (in the long run as their savings build) many more choices when they retire instead of existing on subsistence government handouts.