Intro: While saving is often considered a drag on growth, nothing could be further from the truth. All investment that takes place must come from real savings in one form or another, either saved domestically or borrowed from abroad. More saving may reduce the output of consumer goods in the near term, it does so by increasing the output of capital goods, with the added benefit of greater production of both in the future.
The more savings available in an economy, the greater the potential for businesses to find profitable opportunities for any given amount of labour. The more infrastructure, factories, mechanical equipment, office buildings, and skilled workers that exist, for instance, the more productive labour will become.
The best way to think about savings in the economic sense is ‘all goods produced and not consumed’. Looked at this way it is easy to see why savings are equal to investment. All the investment that takes place in an economy must come from domestic savings or borrowed savings. The more savings a country has, the more investment that can result. Countries can also borrow the savings from overseas (running a current account deficit), but this tends to be costly over the long term.
Far from being a net drag on growth, it proves to be a net benefit as it allows more goods to be produced over the longer term. In the near term, consumption and investment are often substitutes: in order to invest more we have to consume less. However, in the long term they are compliments: the more we invest, the more we ultimately are able to consume as productive capacity increases.
High Savings Rates Make Long-Term Investments More Profitable
Increased savings rates are often considered to be the cause of weak economic growth, but this is rarely the case. If consumers decide to save more, this gradually frees up resources in the economy to be used to produce investment goods, which are demanded by businesses to build capacity. Profitability in the consumer focussed industries will be reduced, but profitability in investment focussed industries will concomitantly increase. Growth isn’t negatively impacted by this. What is lost in terms of consumer goods production is made up for in investment goods production. In terms of the C+I+G+NX framework, while C will fall, I or NX will rise, offsetting the decline.
This differs somewhat to the theories put forward by central banks and the financial media, which often tend to malign savings as a drag on the economy. These theories contend that because consumption is often the lion’s share of GDP, a reduction in consumption is negative for GDP overall. However, this ignores the production of investment goods which benefits when savings rates rise.
How Savings Rates Rise
A rise in a country’s savings rate (or a decline in a country’s public and private consumption as a share of GDP) can result from changes in the preferences of consumers to increase their savings, a reduction in the fiscal deficit, demographic changes, improving terms of trade, tight monetary policy, or changes in tax policy.
How Demographics Impact Savings Rates
An often overlooked demographic factor determining real GDP growth is the percentage of the population which is of working age. Countries with higher ratios of workers to dependents will tend to have higher savings rates as there are more people of saving age. Countries with ageing populations will tend to have lower savings rates as people spend their savings in retirement. This is a major factor explaining China’s high savings rate due to the one child policy.