Cornell economist Robert H. Frank has nice analysis of the savings problem in the New York Times. As he tells it, the problem is that good schools are judged by a relative standard, and when every family is bidding against every family to live in areas with the best schools, it may be rational to forego savings and spend more on housing. (This is similar to the analysis in the book The Two Income Trap.)

He explains this idea as follows:

The basic idea is captured in the following thought experiment:

If you were society’s median earner, which option would you prefer?

-You save enough to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or

-You save too little to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 50th percentile on those tests.

It is an unpleasant choice, to be sure, but most people say they would pick the second option.

But this creates an arms race dynamic that leaves everyone worse off – it’s a classic collective action problem:

Because the concept of a “good” school is relative, this thought experiment captures an essential element of the savings decision confronting most families. If others bid for houses in better school districts, failure to do likewise will often consign one’s children to inferior schools. Yet no matter how much each family spends, half of all children must attend schools in the bottom half.

The savings decision thus resembles the collective action problem inherent in a military arms race. Each nation knows that it would be better if everyone spent less on arms. Yet if others keep spending, it is too dangerous not to follow suit. Curtailing an arms race requires an enforceable agreement. Similarly, unless all families can bind themselves to save more, those who do so unilaterally risk having to send their children to inferior schools.

His solution? Mandatory savings deducted from income growth:

A collective agreement that each family save a portion of its income growth each year would attack both sources of the savings shortfall. Such an agreement might specify that one-third of income growth be diverted into savings until a target savings rate – say, 12 percent of income – was achieved. A family whose income did not rise in a given year would be exempt from the agreement.

I’m not sure mandatory savings will ever be politically viable (or philosophically acceptable), but this is a very clever idea…