How Much Can Americans Cut Back?

By Jennifer Burnett, CSG Senior Research Analyst

The current financial crisis has experts declaring the end to the era of easy credit. But to many, this isn’t entirely negative. For years, we have been warned that Americans are living beyond their means and engaging in irresponsible consumerism while saving and planning for the future less. It is certainly true: Americans are saving less and spending more than ever. Total consumer debt has nearly tripled since 1989. The savings rate of American households has declined over the past 10 years and in 2005 that rate actually turned negative, according to the Commerce Department.

So, if Americans can no longer live on credit, where will they cut back? Is it just a matter of a collective tightening of the belt, or are middle income Americans already stretched to the limit?

Recent trends indicate belt tightening may be more difficult than just putting off the annual vacation or that flat screen TV purchase. The deteriorating and volatile housing market is taking an increased toll on the American consumer. Increasing health care, energy, food and higher education costs are making up a larger percentage of income in recent years, regardless of any shift in cultural attitudes toward spending and saving. The bottom line is that Americans are already struggling to cover their basic living expenses, and cutting back in the short term simply may not be an option.

Here’s how Americans are getting squeezed:

• Housing: The number of middle income households spending more than 50 percent of their income on housing costs—a figure categorically considered to be a severe cost burden— has soared in recent years. Between 2001 and 2006, the number of middle income homeowners spending more than 50 percent of their income on housing increased by 1.4 million, according to 2008 Harvard report, State of the Nation’s Housing.
• Health: Health care coverage costs since 2000 have outpaced increases in wages by a ratio of more than 3-to-1, and have increased 78 percent since 2001. A Harvard report found that either illness, injury or medical bills was a contributor to debt leading to bankruptcy in more than half of those filing for bankruptcy. The average person who declared bankruptcy in 2001was a middle-aged, middle class homeowner.
• Education: According to recent reports, tuition and fees for the average public four-year university have jumped 76 percent since the 2000-2001 school year. Neither family income nor federal tuition assistance programs have kept pace with the increasing cost of higher education. During the 1986-1987 school year, the maximum Pell Grant covered 51 percent of the cost of tuition, fees, room and board at a public four-year college. In the 2004-2005 school year, the same program covered only 35 percent of costs. Increased tuition and fewer grants translate into more debt for graduates: two-thirds of college graduates have student loan debt, with the median borrower owing $19,300..
• Food: For nearly 20 years, we have enjoyed relatively low food costs and low inflation for staples like bread, milk, eggs, flour and cereal. Over the past several years, however, the cost of food staples has skyrocketed. For example, over the past two years: the price of a dozen eggs has risen more than 50 percent, the cost of bread increased by nearly 22 percent, and the cost of a gallon of whole milk increased by nearly 21 percent, according to data from the Bureau of Labor Statistics. Considering that food accounts for approximately 13 percent of household spending, these changes are significant.
• Energy: Although gas prices have fallen in recent months, fuel costs still remain high and take up a larger chunk of the American household income now than it has in the past. The American Automobile Association reported that, nationwide, regular gasoline averaged $3.25 last weekend. While $3.25 is the cheapest gas we’ve seen since this spring, it is still nearly 18 percent more expensive than this time last year, 97 percent more costly than the average cost of a gallon 8 years ago, and is a 242 percent increase from the average in 1998, not adjusted for inflation. Projections also show that households will be paying significantly more to heat their home this winter. Households using fuel oil are projected to spend an average of $2,388—or 23 percent—more than they did last year. Natural gas users will pay 18 percent more this winter and those that use electricity to heat their homes will see an increase of 10 percent in costs.
• Retirement: An AARP report released this month shows that, because of recent changes in the economy, 20 percent of workers age 45 and older have stopped putting money into a 401(k), IRA or other retirement account during the past 12 months.
• Luxuries: Although spending on luxury items such as home entertainment may have increased slightly over the last three decades, this increase has largely been offset by decreased spending on items such as clothing and major appliances that were made less expensive through more efficient manufacturing processes and outsourcing.

Comments

[Jack]

Dave, while it is true that our economy (I'm assuming by economy you mean GDP) is primarily made up of consumption, it’s not necessarily true that a decline in consumption will slow down the economy. This is especially true when the decrease in consumption comes because people are saving more.

Macroeconomists teach us that the economy (GDP) is made up of four components: consumption, investment, government spending, and net exports. Any increase in one component will cause GDP to increase and vice versa. If consumption decreases, GDP will go down; however, if the decrease in consumption happens because people are saving more, then its not a given GDP will decrease. The saved money means more funds are available for investment, and an increase in investment will cause GDP to increase.

In reality, the whole thing gets complicated because the U.S. is an open economy and runs a trade deficit which affects net exports, and in turn affects investment. I guess what I’m saying is it’s not as simple as saying, “Save more, the economy slows, save less the economy prospers.” This statement can be taken to mean that if we want the economy to boom, then we should all spend, spend, spend. And that is not a good economic policy.

[David]

It seems we are in a catch 22. I would agree that consumerism has gotten out of control, driven by the constant marketing and electronics/digital revolution (everyone and his child has a cellphone!). On the other hand, 2/3rds of the economy is driven by the consumer. Save more, the economy slows, save less the economy prospers. How do you find the balance? Throw in the wrinkle of the current credit crisis, and the complexity is magnified. Forced cutbacks won't do it right. We don't have a war that people want to sacrifice for, we don't have the leadership in Washington yet, and we don't even know where we should be going - does anyone?