I know the US economy is largely consumption based, around 70% and there are fears that people are saving money due to uncertainty because it will slow any kind of recovery we face after the virus.
Which makes me wonder, is an economic system with a high savings rate something that would actually work? What benefits are there to a high savings rate?
Like if people (and corporations too I guess) save 30% of their net income each month, what happens? It seems that would constrict the economy but are there benefits?
I heard that a high savings rate leads to lower interest rates on bank loans, which can spur growth. But the US has had near 0% interest rates from the fed despite lots of debt spending by individual consumers, corporations and the federal government. So I’m not sure if that would help if our interest rates are already near 0%.
Is an economy with a 30% savings rate but that also has consistent job growth, low unemployment and 2-3% annual GDP growth possible? If so what should be done with all the savings?
Should they be loaned to foreign nations as cheap capital so they can build their economy, pay interest to us on the debt, then start purchasing our exports?
You know, I believe it could in the right circumstance.
If that savings ends up in banks - and not out of circulation in coffee cans someplace - then it provide extra loanable funds for banks to send out to, yes, promote consumption but also to loan to start up businesses.
I know that big sexy IPOs in the stock market get a lot of the media attention but the vast majority of small businesses fund either by themselves or through what I learned from venture caps at the three ‘Fs’ of first start ups: Family, Friends, Fools.
So there could be a program that promotes lending - a la the Small Business Administration along with SCORE - to small business starts and expansions. That would bounce economic growth and employment.
Sure, consumption is important - though I have doubts about a sustained consumer economy - but small businesses consume at a pretty fast clip. As do their suppliers and delivery firms and such.
In fact a high savings rate is generally more conducive to economic growth. That has pretty much been the basic model of China and fast-growing East Asian economies in the last several decades. It’s useful to think of the four basic components of GDP: consumption, investment (which includes business expenditure on capital goods like factories, equipment etc), government purchases and net exports. A higher savings rate does mean lower consumption but then through the financial system the money is routed to companies who use it to finance their investment expenditure. Over time this investment expenditures increases the capital stock of the economy which means more infrastructure, factories and equipment which means higher productivity.
The big exception to this is a financial crisis when consumer confidence and therefore consumption falls but so does investor confidence and investment. What happens to the economy when both consumption and investment fall ? A recession unless the demand comes from somewhere else like a fiscal stimulus which increases government purchases. However this is an exception and the history of East Asian economies shows it is perfectly possible to grow fast for decades with a high savings rate.
If we redirected much of the money the 1% (or .1%) is getting now to the masses - through higher wages, not handouts - the savings rate as a whole might go down, but the number of people saving would go up, as would consumption which is good for the economy. People feeling secure would save more. And the savings would probably be in less volatile instruments than it is today, so less of it would vanish in market downturns.
I doubt you’d get a 30% savings rate or anything close to it for most people, since many people have a lot of catching up to do.
I’m counting putting money in the market as savings - I don’t know if that was what was meant by the OP.
My own personal bugaboo would be removing employer-sponsored retirement plans altogether. 401ks, SIMPLEs, what-have-you.
And then making them a federal process. So everyone who works has a 401k or equivalent that they have to contribute to - and employers do some matching to depending on their size. At retirement, that savings becomes either cash or a pension, depending.
But it’s a pipe dream. I sell 401ks to companies. There’s WAY to much money involved to ever see it publicized.
There are times when this is true, but for the last decade, the banks have been sitting on trillions of dollars in reserve, looking for a place to loan it out.
Right now, it’s even more ridiculous, where there is effectively no reserve requirement. Banks are knocking down the doors of small businesses trying to get them to take some of this money. (Plus side, for a small business, it’s never been easier to get a loan.)
In that example though, doesn’t most of the growth come from exports? It is fine to have your domestic population saving money, if the rest of the world is pumping money into your economy.
Outside of government purchases, our economy is a consumer economy, it is driven nearly entirely based on what the consumer has and is willing to spend. Investment follows demand, a company will only increase their capacity, investing in new equipment and labor, if their current capacity does not meet the demands of the consumer.
With higher wages, you could have increased savings, while also having increased spending, but wages tend to stay flat, and any profits from increased efficiency or price increases tend to go to the owners, rather than the workers. In fact, cutting wages and jobs is one of the primary ways that companies make themselves more profitable, leaving less money to the consumer for both spending and saving.
This is true, and probably a great policy prescription for any developing economy looking to tiger up its economy. But I don’t think you can extrapolate from that to how a high savings rate would affect a more established, mature economy - or the world as a whole for that matter. In particular, those East Asian economies have been very export-driven, which means outsourcing[sup]*[/sup] the consumption part of the formula. If there’s no one to outsource that to, the whole setup may fail.
That said, there’s probably some optimal savings rate given a variety of inputs. I couldn’t hazard a guess on what it is, and I don’t even know if it would qualify as ‘high’ to you or anyone else, but I would think there must be some interesting papers on the topic in the academic economics literature.
[sup]*[/sup]‘outdestinationing’?
ETA: sorry, somehow missed your post when I wrote this, k9bfriender. I’d say I got ninja’d, but it was 22 minutes, so really no excuse…
I’m not an economist but this is my understanding.
If a high savings rate worked in east asia, that was because those nations as they developed had export based economies. They would perform a lot of low skilled manufacturing of products that were exported to foreign nations. As the US is a developed nation, this isn’t an option. Developed nations earn their income from provide highly skilled manufacturing and providing highly skilled services. The fact that asian tigers had high savings rates while providing low skilled manufacturing for export probably won’t apply to our economy.
Can a wealthy, developed nation grow with a high savings rate? Our economic model seems totally different than a developing nation. Ours seems based on highly skilled services and manufacturing, much of which goes to domestic consumption while developing nations provide lower skilled agricultural work and low skilled manufacturing for export.
As far as the money being loaned to businesses, in the US our interest rates are near 0 despite our low savings rate. So would more savings make a different? Interest rates can’t really get much lower.
Also I thought China was facing issues due to the high savings rate and was looking for ways to increase domestic consumption. Consumption is being held back by things like the fact that a lot of people of working age are expected to support themselves, parents and children in a society without much safety nets.
Production in an economy is a function of productive resources: labor, capital (meaning equipment, not money), technology, etc.
Production = F(L, K, tech, …)
As an individual, you can save by having an income greater than your outgo. But an economy as a whole cannot do that, because my income is someone else’s outgo. Every dollar I earn in income was an expenditure for someone else. For the economy as a whole, Income = Expenditure.
What saving literally is, in a macroeconomic sense, is producing without consuming. In a closed economy, this means producing investment goods – capital equipment – rather than consumption goods that are used immediately and are then gone. So if we’re saving, rather than consuming, then what we’re doing is creating more capital equipment.
F(L, K⇡, tech, …) = Production⇡
And that means that future production will be higher, as long as the investment wasn’t horrifically ill-chosen. More saving means more equipment that helps us make things, which means higher future production.
This is going to be true for every economy, not just developing economies.
The difference is that developing economies have a lot of low-hanging fruit available, obvious investments that will yield obvious rewards. Access to global trade networks means access to comparative advantage, and that will necessarily lead to exports in a country with high savings. But it’s not the exports that are “creating” the growth. Growth comes from more productive resources, like capital equipment. If you build machines that help you produce more in the future, then you will produce more in the future. Exports – or even more precisely, trade – can help finance investment which leads to higher growth, but exports don’t create higher growth, at least not in and of themselves. The growth comes from the investment in capital equipment. And even developed countries can build more and better capital equipment, which will lead to higher production in the future.
The exports are important – comparative advantage is important – but it’s a distraction from the primary causal driver here. It’s the investment that ultimately drives the process of higher growth.
Developed countries do not necessarily have the obvious investment opportunities that developing countries have. The risk of investment is planting your seeds in unknown soil. Maybe the seed will sprout into a tree that gives many more seeds. But maybe the soil is bad and your seed dies – your investment is a failure. A developing country can look at the numerous examples around them, and see which kinds of soil have been particularly fertile. They can make the easy investments first. A developed country, which has already taken advantage of all of the easy investments, has to take more risks with the types of unknown soil it plants its savings into. Many of those choices will be failures, and the seeds will die. The investments will be a failure.
But a rich country can potentially have a lot of people with extra seeds, and a desire to find new soil despite the risk. Even with the numerous anti-saving policies of the US government, it’s still extremely common for extremely productive new high-tech industries to have their start in the US. Some people with savings to risk will take chances. Most of their seeds will die, but the ones that don’t can be – and very often are – ridiculously productive.
More saving means more opportunities to try things.
Total consumption can easily go up over time with a higher savings rate, even if consumption as a percentage of the economy goes down. That’s really what growth is about.
Under this model, does buying stocks count as savings or consumption? Buying into an IPO where the money goes directly to the company I think could clearly be called savings, but in general buying stock does not go to the company issuing the stock.
I’ve done many proposals for R&D projects, which are somewhere between capital expenses and start ups, and what is involved is expected RoI, risk, and comparison to the RoI of safer investments. My company had a return value you had to beat to even have a hope of being funded.
As far as national saving is concerned: having your income exceed your consumption counts as saving.
The purchase of stock is almost incidental to that. It doesn’t matter what you do with it. You could keep the extra money in a sock drawer, and your income would still be higher than your consumption, and therefore you would be saving. But your own behavior must be balanced with others. If you are consuming less than you are earning from productive income, but someone else is consuming more than the value they are producing, then the net could be zero. Or if literally everyone in the country consumed less than their income, and literally everyone kept the extra cash in their sock drawers, then country would have positive saving: it would necessarily be the case that production had exceeded consumption. The difference is saving.
That is not how investment is typically financed. But there’s nothing logically impossible about it. It’s just how the definitions work. If we produced but didn’t consume, then in a closed economy, the difference must necessarily have been production of capital goods.
In an open economy, the difference is either production of capital goods or accumulation of foreign assets. Or talking about sectors: the concept of “personal saving” is also somewhat more complex than national saving, because it’s part of the division of the economy into sectors. But when the sectors are recombined, we return to saving defined as production which is not consumed, either by private households or by government.
This is all just definitional, not even a “model”. It’s how the National Income and Product Accounts in the US are defined.
It’s not the purchase of an IPO, directly, that counts as saving. If the corporation sat on the cash raised from the stock offering, rather than purchasing equipment, there would still be no national saving from it. Or if they solely financed the salaries of employees, who then consumed the entirety of that income, there would be no saving. You might personally have income in excess of your consumption (“saving”), used to purchase newly issued stock, which is then hypothetically kept as cash rather than used for capex. Then someone else might have consumption in excess of their income, hypothetically financed with debt or previous savings, so that their own saving is negative, matching your own positive saving.
In that case, the net is no saving, despite the purchase of IPO stock.
Saving is defined as production that is not consumed. The definition does not try to incorporate how exactly this production was financed.
Hellestal, your posts here have been great. I’m curious, though, if you have thoughts on the core of the OP’s question:
Specifically, to what degree could a mature economy (like the US) increase its growth rate by increasing its savings rate, and at what level of savings do those advantages taper off?
I don’t have great data to offer you, but I can offer up a snarl here. The “mature” economies are financialized and rotten to the core. The overwhelming majority of “investment” in such economies is really malinvestment. Things that should fail are rewarded, things that should be strongly rewarded are brutally punished, and in general there is very little investment linked to increased productivity.
Nobody is doing any major capex (capital expenditures) with the massive amounts of debt they’re taking out. They’re increasing administrative costs by jacking up salaries and payouts, or repurchasing shares to… well, jack up payouts. There’s wild speculation because there’s no yield in more sound or productive investments (thank the fed), and virtually everything is engineered to make savings toxic.
If you only change the savings rate, then it’s pretty disastrous for the “mature” economies. You must clear out the dead wood and eliminate these stupid, perverse incentives.
The top marginal tax rate needs to double, at minimum, and preferably return to over 90%. Once you have more money than you can meaningfully benefit from in any remote capacity, you need to be rather draconically incentivised to direct it elsewhere. Like capital expenditures. Or worker salaries.
Just to clarify for my understanding. When you say “economy a a whole” you mean the world economy, correct? Because income and outgo cross borders, no individual nation or unit can balance them.
Doesn’t that therefore mean that individual nations can and do have incomes larger than outgos? What is the result of that?
It’s virtually certain that the US could noticeably increase its growth rate with a higher savings rate, absent some crazy-ass Soviet-style misallocation of spending. My work goes more into business cycles than long-run growth, so I’ve never calibrated a model to guesstimate-- or hrrm, econometrically determine what the optimum “golden rule” (or modified golden rule) savings rate would be for the US.
You’re right that eventually we’d hit diminishing returns.
We wouldn’t necessarily want gross saving* at over 50% of GDP like Singapore has, even tho their GDP per capita is over 100k (PPP) and ours is closer to 60k. The US does a lot of things right that most countries don’t, and Singapore does even more things right that the US doesn’t. Not to mention two very, very different kinds of economies just in scale. We can’t hit the Singapore level, and we shouldn’t try.
But we could do better than our current 17%.
The 30% mentioned in the OP is totally doable. I mean, as long as we didn’t try to implement it overnight. That would not work. The ideal here would be to slowly roll back policies that hurt savers, while implementing policies that help them. Nothing extreme, and nothing done quickly. But honestly, it doesn’t seem like this topic is ever really on anyone’s radar. Understandable right now, but even before the current SARS-2 mess, savings rates just didn’t ever seem to capture anyone’s attention. Just not a sexy topic. I don’t know why…
*Gross saving is almost identical to “public saving” as I defined it above, except it includes some net international transfers and taxes.
In that context, yes. That’s the macro-est of macro levels.
Well, they could implement policies that helped push more to balance.
For instance, if the US wanted to have more exports, compared to imports, we’d need to have a higher savings rate to accomplish that. There’s not really any other plausible way. We import a lot because we don’t save much, which is to say we spend more on stuff than we produce internally. The difference is imports. But to change that, we’d need to do pretty much opposite of what we’re doing on many current policy issues.
I alluded to that a little later in my following post, but I provided no detail:
Differences of income and expenditure result in a net transfer of assets across borders.
We buy stuff using pieces of paper.
The US with its paltry savings rate runs large current account deficits, which result in US pieces of paper going overseas in order to finance those imports. As for what effect that has? It’s surprisingly little, actually. A lot of the US assets that go overseas are low-return stuff, just plain dollars, either the direct green stuff or Treasuries. In contrast, the assets that US citizens acquire from overseas tend to be high-yield stuff.
So even tho we send more assets abroad than we pull in from overseas to finance those imports – and we do this every single year – the relative value of the two categories is vastly different. The stuff we send abroad doesn’t really gain much, if any value, in comparison to the stuff we acquire, which tends to become more valuable over time. The net change in wealth is actually much smaller than people tend to think, despite the constant net flow of assets out of the country to buy imports. In addition, other countries use the dollars they get from us as a “reserve” currency. They hold it in their vaults, so to speak, to use it for other purposes.
As it pretty much has to be. If that weren’t the case, then the world would eventually become so flooded with dollars that it would drive down the USD’s value internationally, and we’d buy less from overseas simply because we could no longer afford it. We’d also export more, because our stuff would become cheaper for overseas buyers. A sort of pressure valve, there, tho not one that would mitigate any other internal effects of low savings rates.
If I’m understanding you correctly, you’re saying that savings can lead to growth since those savings are used to invest in technologies that increase productivity in the economy. Maybe a factory automates some lines, maybe a mining operation buys a 100 ton truck to replace the 50 ton truck, an office invests in software that automates 30% of daily tasks, etc.
However it was my understanding that there are trillions in idle capital in the global economy. In the US alone, we have trillions in idle capital.
One argument I’ve heard is that in developed nations, the issue isn’t a lack of financial capital. It is a lack of good investment vehicles.
So would increased savings rates go to increased productivity? Also what role does the economy rewarding the people who create productivity play? It is my understanding that a lot of people end up leaving fields like science and technology due to poor job prospects. People who work in these fields create the next generation of R&D developments that lead to increased productivity. However if those people end up leaving the field because they can make more money working in law, business, or as garbage collectors how do you ensure that the technology to create a new generation of productivity advances is still there? Fields like academia or industrial R&D may produce a lot of innovations but if good job prospects aren’t there, labor will leave these fields for other fields which means the next generation of advances in productivity doesn’t happen, or happens far slower.
I appreciate the post though, I just don’t understand why more savings will lead to more investments into things that make businesses more productive. One one hand it seems businesses are already sitting on trillions in idle capital, and as a society we aren’t incentivizing enough people to create the next generation of new technologies that can be implemented.
Also I was under the impression that a lot of investment capital is being used to create bubbles. Like real estate bubbles, a lot of global capital is devoted to purchasing real estate which doesn’t really achieve much other than increasing housing prices in certain metro areas.
Whats to stop wealthy individuals or wealthy companies from investing $100 billion in savings into purchasing real estate in Vancouver, Sydney and San Francisco, instead of spending that $100 billion in investing in R&D and business equipment so they can be more competitive in a global economy?
Would taxing idle capital and using it to help subsidize R&D be a better use of it?
The most parsimonious explanation for idle capital is that some companies are rich enough that they are maintaining liquid emergency funds. Standard financial advice is for a household to put six months of expenses in an emergency fund that can be easily accessed. Most companies would not be able to do that, but companies that are rich enough would be able to do something similar. Forcing them to invest their rainy day funds in riskier investments would increase growth but at the cost of fragility in a crisis like the current one.