How Saving Too Much Can Sap Economic Growth

By Brent Radcliffe | October 19, 2011 AAA
How Saving Too Much Can Sap Economic Growth



What causes economies to grow? This question has been both the fire beneath the feet of economists, business leaders and politicians and the bane of their existence for centuries. The most common measure of an economy, the gross domestic product (GDP), shows that growth depends on a combination of consumption, government expenditures, investments and net exports. In recent decades, the cost of obtaining capital had declined, making it cheaper for countries to gain access to funds in order to develop.
TUTORIAL: Economic Indicators: Gross Domestic Product (GDP)

For an economy, "saving" is more than just what one household tucks away in the bank. Economists aggregate the savings from households, governments and businesses into "gross national saving," or GNS, which is a sum of all after-tax income, less what is consumed. It's typically compared to the overall GDP of a country. When it comes to GDP analysis, "investing" isn't what you put in your retirement account, it's the amount of money put into physical assets, like factories and railroads. (GDP is the typical indicator used to measure a country's economic health. For more, see High GDP Means Economic Prosperity, Or Does It?)

Developing countries historically have had higher GNS rates than their developed global counterparts. In fact, the GNS rate between 2000 and 2010 for some of the fastest growing Asian economies has grown substantially: China (by 45%), Indonesia (23%) and the Philippines (59%). Comparatively, the GNS growth rate of developed economies, listed in the top 10 of all economies, in terms of GDP (2010 figures): United States (-31%), Japan (-15%), France (-11%), United Kingdom (-21%), Italy (-16%) and Canada (-19%). Only Germany (12%) saw a savings rate growth.

Why have savings rates increased so much in the developing world? As developing countries modernize, they draw more of the population into modern industries, such as manufacturing. Workers earn more money, which they tuck away, rather than spend on goods and services. One reason workers in developing countries don't devote as large a portion of their income to consumption is that there aren't many things for them to spend money on. Developing countries often have a positive trade balance, meaning that they focus on sending goods abroad, and may not devote as much capital pushing for the creation of industries serving the domestic population.

Aging Populations
Another factor that will affect China, and other developing countries, is the aging of the population. As populations in countries retire, they tend to save less since they're no longer working; they draw down on their savings. This phenomenon will gather steam in the coming years, as the populations of developed countries tend to be older. For developing countries with larger youth populations, the savings rate will actually increase as more and more young people move into the workforce and earn incomes. Additionally, high birth rates, relative to developed countries, keep the population in developing countries comparatively young, accelerating the savings rate (this could be offset by the eventual fall in birth rates that countries experience upon becoming developed). In order to amp up consumer spending, central banks and governments would need to encourage households to take on more debt or decrease their savings rate.

Will high savings rates and low consumption continue? It's unlikely. There has been much ballyhoo in recent years over China's insatiable appetite for the commodities and materials needed to fuel its building boom. China and other developing Asian countries are rapidly urbanizing, which requires new infrastructure and housing, as well as all of the tools and machinery required to build it. Investors will pour capital into these countries, which will push up interest rates.

Interesting Position for Developing Countries
Developing countries, thus, find themselves in an interesting position. On one hand, they have access to huge pools of capital, thanks to years of high savings rates, allowing them to tap into those funds for infrastructure development and to build up foreign-exchange reserves. On the other hand, individuals and businesses that plunk money into a bank as savings, aren't using income to consume goods and services. Central banks want growth to continue, yet, at the same time have to temper growth aspirations with the desire to keep exchange rates in check and economic bubbles small. The allocation of capital can be especially tricky for emerging markets, because they lack deep and mature financial systems, and the financial institutions that they do have might not be accessible to all of the population. (For more on central banks, see What Are Central Banks?)

If savings rates fall, as emerging market populations consume more of their income, age demographics shift toward the right, and as investment, new buildings and infrastructure in developing countries sop up available capital, what will happen to world interest rates? They will go up. This is a poignant topic because capital has, more or less, flown freely between countries for decades. Cheap capital helped contribute to excessive accumulation of debt in the West. If capital becomes more expensive to obtain, then borrowers will have to think more about taking on more debt due to the cost of servicing it.

The Bottom Line
Because capital can move, more or less, freely, businesses will compete for funds, meaning that the businesses able to achieve the highest return per unit of capital will be at an advantage. The financial institutions providing the go-between between investors and businesses may actually see an increase in savings rates as investors find higher interest accounts more attractive. For governments in developed economies, such as the United States, this may come as a blessing, allowing policies to be crafted to shift the population toward saving, and away from consuming. The biggest risk, however, could be the further intertwining of the global financial system. The simpler it is to engage in cross-border financing and shift capital to the most productive areas, regardless of location, the harder it will be for governments and central banks to make truly autonomous decisions.

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