Saving rate and growth
Content
Essay on relationship between Saving rate & Economic growth
Submitted to Dr. Shuddhasattwa Rafiq Course Instructor Macro Economics JU-WMBA
Submitted by Md. Jakaria Alam Id. 2012 01095
Submission date: July 13, 2012
Q. Discuss the relationship between the saving rate and economic growth for a country of your choice. Preparing the essay the question to be considered What is the saving rate and how is the saving rate measured? Is the saving rate of selected country is low or high compared to similar countries? What is the theoretical view on the relationship between the saving rate and economic growth? What is the evidence of the relationship between the saving rate and economic growth for your chosen country?
Answer According to national income identity the amount that remains after deducting consumer and government expenditure from output or yield is national saving or simply saving. S=Y–C–G Where, S = National Savings Y = output C = Consumption G = Government expenditure National saving consists of two units. One is savings of public sector or government saving and the other is public savings. Public saving is the amount remaining after deducting government expenditure from government revenue. Government savings = Tax – revenue Public saving simply means the portion of disposable income not spent on consumption of consumer goods. According to Keynesian economics, saving is the amount left over when the cost of a person's consumer expenditure is subtracted from the amount of disposable income that he or she earns in a specific period of time. Public Saving = Y – T – G Where Y = output T = Tax G= government expenditure
Saving rate According to Investopedia, Saving rate is the amount of money, expressed as a percentage or ratio, which is deducted from his/her disposable personal income to set aside as a nest egg or for retirement. The amount accumulated is typically put into very low-risk investments like government bond, mutual funds, stocks etc. Economic growth Economic growth of a country simply referred to as the economy's capability to increase the productivity of goods and service in comparison with previous year. The economic growth can be calculated both in real terms and in nominal terms. The two main factors that define economic for any countries are Gross Domestic Product(GDP) Gross National Product(GNP)
How to measure saving rate In order to measure saving rate in an economy first of all we have to determine the amount of Disposable Income for a particular year. It can be found in different statistics published by different agencies. For example if we are looking for any sort of data of any European countries we can have the statistics of OECD. Than we have to find out the consumption of that country in that year. Than we have to determine private saving which we can get from subtracting household consumption expenditure from household disposable income plus the change in net equity of households in pension funds. We will also have to find out tax of that particular year. Moreover we have to find out the total government expenditure of corresponding year. After getting all those data we have to calculate public saving and then we have to add those two units to get national savings. And finally we have to divide National Savings by the sum of Total Income and Taxes in order to get saving rate. Saving is an important element for long term financial stability as it gives a person or organization a cushion for bad times. A higher savings rate may result in slower economic growth as people and companies are saving instead of buying goods and services. On the other hand, a lower or negative savings rate usually points excessive borrowing, spending, or both. Saving leads to greater availability of funds to lend which in turn leads to lower interest rates. Lower interest rate creates better opportunity for business investment. Investments lead to business expansion, which leads to more employment, which leads to economic growth. According to famous economist Solow if the saving rate is high, the economy will have a large capital stock and high level of output in the steady state. And if the saving rate is low the economy will have a lower capital stock and comparatively lower output in the steady state. Higher saving leads to faster growth but the growth is temporary. An increase in saving rate raises growth until the economy reaches the new steady state. He developed a model based on that theory. The model also states that, if a nation devotes a large fraction of its income to saving and investment, it will have a high steady-state
capital stock and high level of income. But if a nation saves and invests only a small fraction of its income, its steady-state capital and income will be low. In this model, the rate of technical change, the savings ratio and the rate of population growth are the three parameters that determine the rate of growth of the economy in steady –state. Solow along with two other economists Mill-Marshall Stated that it is assumed that all savings is automatically invested and translated into output growth under wage–price flexibility and full employment. As a result, savings leads economic growth. Saving affects national growth positively as we know that whatever we save is the investment of a country. The investments are then used for production purpose. In some countries government provide tax exemption for saving money and invest thus earned capital in various development projects of the country that help to build a better economy. This also helps for the growth of economy. As a result new enterprises start up their business and generate lots of employment opportunity. These will result in a higher level of GDP and per capita. A research of 32 countries by Krieckhaus (2002) reveals that a higher level of national savings led to higher investment and therefore caused higher economic growth. However, the issue of relationship between savings and growth is controversial. In the neoclassical growth model of Solow saving is exogenously given. On the other hand, according to Keynesian theory saving is endogenously determined as a result of the interactions between income and consumption. Higher growth causes higher incomes that lead to higher savings. Carroll and Weil (1994) provided strong evidence regarding the fact that growth causes saving. Finland Finland is a Nordic country located in the Scandinavian region. Finland is one of the highly industrialized nations of the world. It has a large free-market economy with GDP per capita 36664 US dollar. It is highly involved in Trade and exports accounts for over one third of GDP in recent years. Finland is highly competitive in manufacturing - primarily the wood, metals, engineering, telecommunications, and electronics industries. Finland is the only country in the Nordic region which includes itself in the euro zone. Before 2006, Finland had been one of the best performing economies within the EU in recent years and its banks and financial markets avoided the worst of global financial crisis. However, due to recession its exports and domestic demand was affected hard in 2009. And because of that Finland is experiencing one of the deepest contractions in the euro zone. However a recovery of exports, domestic trade, and household consumption stimulated economic growth in 2010. Saving rate of Finland is low compared to other countries of Nordic region like Norway, Denmark Sweden, Poland and saving rate of Nordic region is low compared to other country of euro zone. Numerous factors can help explain country differences in household saving rate, such as income taxes, inflation, the pension system, stock and housing prices, real interest rate, female employment rate or the volume of shadow activities. The country having higher taxes imposed have lower saving rates compared to countries with lower tax. Along with tax health care and retirement income are provided by the governments in those countries are also responsible for lower saving rate. In those countries people find less attractive to save their money than in less developed countries where people must save for retirement and medical costs. Saving rate of those Nordic countries was higher before economic downturn in 2006 and after that saving rate continues to decline till 2009. During the economic downturn Finland was affected severely because of its involvement in trade with European countries
and people of Europe consumed less than they used to consume. Social safety net and demographic composition of the people are also responsible for lower saving rate in those Nordic countries. Due to economic downturn people lost their jobs and government had to pay huge amount of money as unemployment benefit. Demography is also important factor as aged population of those countries was higher. Due to sickness and retirement benefits government of those spent huge amount of money for those sage people. As a result government saving reduced as well as private saving also reduced due to unemployment and less disposable income. Along with those variables there are other variables like inflation rate, real income growth rate and interest rates change account for changes in less saving rate of people of Norway, Denmark Sweden, Poland and Finland.
Saving Rate
20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009
Norway
Finland
Denmark
Sweden
Source: Eurostat and OECD
250.0 200.0 150.0 100.0 50.0 0.0 2003 4 5 6 7 8 9 10 143.8 156.1 161.0 191.2 174.3 200.8 188.1 196.6
Gross domestic product (GDP) Bln USD curr. PPPs
40 000 36 165 35 000 30 081 30 000 25 000 20 000 15 000 10 000 5 000 0 2003 2004 2005 2006 2007 27 383 30 831 33 409
37 992 35 905
37 181
2008
2009
2010
GNI(per capita)
Source: OECD
Here is the data of Finland’s savings rate and two of its economic indicators GDP and GNI presented in graph to show the relationship of saving rate and growth. As we can see that from 2001 to 2006 saving rate increased and due to increase GNI and GDP. Recession brought down saving rate after 2006 and as a result GDP and per capita income of Finland also decreased. So we can say that saving rate is positively related to economic growth of a country. However only decrease in saving rate was not responsible for less GDP and GNI in Finland. Finland’s high exposure in trade along other countries is the major cause of less economic growth as its export fall drastically because of less disposable income by most people of the European nations. Higher government expenditure in social safety is also responsible as governments had to pay huge amount of unemployment allowance. The relation of saving rate and economic growth is not as simple as it is explained theoretically. There are countries in the world that have better economic growth even though they don’t have substantial amount of savings rate. Such country can borrow their funds from other countries though they don’t have enough domestic saving’s and can invest in their development works. Low saving rate also indicates higher economic growth in a sense that people will consume more and more consumption results in higher production which create more employment and a higher GDP. Saving rate is an key indicator of economic growth of country and a higher saving rate is good for a nation. In the short run it may seems negative for a country as we know that saving is part of disposable income that remain after consumption. So a higher saving rate indicates a less consumption. However in the long run we assume that all the savings are automatically invested and as the investments in
developments activities create more production, more employments and more personal income for everyone in an economy.
Bibliography
1. Mankiw, N.G (2006) Macroeconomics. 6th edition. New York : worth publisher. 2. OECD library (2011). Paris. Economic outlook 83. 3. Mohan, R (2006) Causal relationship between savings and economic growth in countries with different income levels. 4. Aghion, P ‘et al.’ (2009) When Does Domestic Saving Matter for Economic Growth? 5. Rafiq, S. (2012) saving and investment- the open economy. JU-WMBA. 07th July2012. Available from PPT slide. 6. www.investopedia.com 7. GUTIÉRREZ, M and SOLIMANO, A (2007) Savings, Investment and Growth in the Global Age: Analytical and Policy Issues.
Submitted to Dr. Shuddhasattwa Rafiq Course Instructor Macro Economics JU-WMBA
Submitted by Md. Jakaria Alam Id. 2012 01095
Submission date: July 13, 2012
Q. Discuss the relationship between the saving rate and economic growth for a country of your choice. Preparing the essay the question to be considered What is the saving rate and how is the saving rate measured? Is the saving rate of selected country is low or high compared to similar countries? What is the theoretical view on the relationship between the saving rate and economic growth? What is the evidence of the relationship between the saving rate and economic growth for your chosen country?
Answer According to national income identity the amount that remains after deducting consumer and government expenditure from output or yield is national saving or simply saving. S=Y–C–G Where, S = National Savings Y = output C = Consumption G = Government expenditure National saving consists of two units. One is savings of public sector or government saving and the other is public savings. Public saving is the amount remaining after deducting government expenditure from government revenue. Government savings = Tax – revenue Public saving simply means the portion of disposable income not spent on consumption of consumer goods. According to Keynesian economics, saving is the amount left over when the cost of a person's consumer expenditure is subtracted from the amount of disposable income that he or she earns in a specific period of time. Public Saving = Y – T – G Where Y = output T = Tax G= government expenditure
Saving rate According to Investopedia, Saving rate is the amount of money, expressed as a percentage or ratio, which is deducted from his/her disposable personal income to set aside as a nest egg or for retirement. The amount accumulated is typically put into very low-risk investments like government bond, mutual funds, stocks etc. Economic growth Economic growth of a country simply referred to as the economy's capability to increase the productivity of goods and service in comparison with previous year. The economic growth can be calculated both in real terms and in nominal terms. The two main factors that define economic for any countries are Gross Domestic Product(GDP) Gross National Product(GNP)
How to measure saving rate In order to measure saving rate in an economy first of all we have to determine the amount of Disposable Income for a particular year. It can be found in different statistics published by different agencies. For example if we are looking for any sort of data of any European countries we can have the statistics of OECD. Than we have to find out the consumption of that country in that year. Than we have to determine private saving which we can get from subtracting household consumption expenditure from household disposable income plus the change in net equity of households in pension funds. We will also have to find out tax of that particular year. Moreover we have to find out the total government expenditure of corresponding year. After getting all those data we have to calculate public saving and then we have to add those two units to get national savings. And finally we have to divide National Savings by the sum of Total Income and Taxes in order to get saving rate. Saving is an important element for long term financial stability as it gives a person or organization a cushion for bad times. A higher savings rate may result in slower economic growth as people and companies are saving instead of buying goods and services. On the other hand, a lower or negative savings rate usually points excessive borrowing, spending, or both. Saving leads to greater availability of funds to lend which in turn leads to lower interest rates. Lower interest rate creates better opportunity for business investment. Investments lead to business expansion, which leads to more employment, which leads to economic growth. According to famous economist Solow if the saving rate is high, the economy will have a large capital stock and high level of output in the steady state. And if the saving rate is low the economy will have a lower capital stock and comparatively lower output in the steady state. Higher saving leads to faster growth but the growth is temporary. An increase in saving rate raises growth until the economy reaches the new steady state. He developed a model based on that theory. The model also states that, if a nation devotes a large fraction of its income to saving and investment, it will have a high steady-state
capital stock and high level of income. But if a nation saves and invests only a small fraction of its income, its steady-state capital and income will be low. In this model, the rate of technical change, the savings ratio and the rate of population growth are the three parameters that determine the rate of growth of the economy in steady –state. Solow along with two other economists Mill-Marshall Stated that it is assumed that all savings is automatically invested and translated into output growth under wage–price flexibility and full employment. As a result, savings leads economic growth. Saving affects national growth positively as we know that whatever we save is the investment of a country. The investments are then used for production purpose. In some countries government provide tax exemption for saving money and invest thus earned capital in various development projects of the country that help to build a better economy. This also helps for the growth of economy. As a result new enterprises start up their business and generate lots of employment opportunity. These will result in a higher level of GDP and per capita. A research of 32 countries by Krieckhaus (2002) reveals that a higher level of national savings led to higher investment and therefore caused higher economic growth. However, the issue of relationship between savings and growth is controversial. In the neoclassical growth model of Solow saving is exogenously given. On the other hand, according to Keynesian theory saving is endogenously determined as a result of the interactions between income and consumption. Higher growth causes higher incomes that lead to higher savings. Carroll and Weil (1994) provided strong evidence regarding the fact that growth causes saving. Finland Finland is a Nordic country located in the Scandinavian region. Finland is one of the highly industrialized nations of the world. It has a large free-market economy with GDP per capita 36664 US dollar. It is highly involved in Trade and exports accounts for over one third of GDP in recent years. Finland is highly competitive in manufacturing - primarily the wood, metals, engineering, telecommunications, and electronics industries. Finland is the only country in the Nordic region which includes itself in the euro zone. Before 2006, Finland had been one of the best performing economies within the EU in recent years and its banks and financial markets avoided the worst of global financial crisis. However, due to recession its exports and domestic demand was affected hard in 2009. And because of that Finland is experiencing one of the deepest contractions in the euro zone. However a recovery of exports, domestic trade, and household consumption stimulated economic growth in 2010. Saving rate of Finland is low compared to other countries of Nordic region like Norway, Denmark Sweden, Poland and saving rate of Nordic region is low compared to other country of euro zone. Numerous factors can help explain country differences in household saving rate, such as income taxes, inflation, the pension system, stock and housing prices, real interest rate, female employment rate or the volume of shadow activities. The country having higher taxes imposed have lower saving rates compared to countries with lower tax. Along with tax health care and retirement income are provided by the governments in those countries are also responsible for lower saving rate. In those countries people find less attractive to save their money than in less developed countries where people must save for retirement and medical costs. Saving rate of those Nordic countries was higher before economic downturn in 2006 and after that saving rate continues to decline till 2009. During the economic downturn Finland was affected severely because of its involvement in trade with European countries
and people of Europe consumed less than they used to consume. Social safety net and demographic composition of the people are also responsible for lower saving rate in those Nordic countries. Due to economic downturn people lost their jobs and government had to pay huge amount of money as unemployment benefit. Demography is also important factor as aged population of those countries was higher. Due to sickness and retirement benefits government of those spent huge amount of money for those sage people. As a result government saving reduced as well as private saving also reduced due to unemployment and less disposable income. Along with those variables there are other variables like inflation rate, real income growth rate and interest rates change account for changes in less saving rate of people of Norway, Denmark Sweden, Poland and Finland.
Saving Rate
20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009
Norway
Finland
Denmark
Sweden
Source: Eurostat and OECD
250.0 200.0 150.0 100.0 50.0 0.0 2003 4 5 6 7 8 9 10 143.8 156.1 161.0 191.2 174.3 200.8 188.1 196.6
Gross domestic product (GDP) Bln USD curr. PPPs
40 000 36 165 35 000 30 081 30 000 25 000 20 000 15 000 10 000 5 000 0 2003 2004 2005 2006 2007 27 383 30 831 33 409
37 992 35 905
37 181
2008
2009
2010
GNI(per capita)
Source: OECD
Here is the data of Finland’s savings rate and two of its economic indicators GDP and GNI presented in graph to show the relationship of saving rate and growth. As we can see that from 2001 to 2006 saving rate increased and due to increase GNI and GDP. Recession brought down saving rate after 2006 and as a result GDP and per capita income of Finland also decreased. So we can say that saving rate is positively related to economic growth of a country. However only decrease in saving rate was not responsible for less GDP and GNI in Finland. Finland’s high exposure in trade along other countries is the major cause of less economic growth as its export fall drastically because of less disposable income by most people of the European nations. Higher government expenditure in social safety is also responsible as governments had to pay huge amount of unemployment allowance. The relation of saving rate and economic growth is not as simple as it is explained theoretically. There are countries in the world that have better economic growth even though they don’t have substantial amount of savings rate. Such country can borrow their funds from other countries though they don’t have enough domestic saving’s and can invest in their development works. Low saving rate also indicates higher economic growth in a sense that people will consume more and more consumption results in higher production which create more employment and a higher GDP. Saving rate is an key indicator of economic growth of country and a higher saving rate is good for a nation. In the short run it may seems negative for a country as we know that saving is part of disposable income that remain after consumption. So a higher saving rate indicates a less consumption. However in the long run we assume that all the savings are automatically invested and as the investments in
developments activities create more production, more employments and more personal income for everyone in an economy.
Bibliography
1. Mankiw, N.G (2006) Macroeconomics. 6th edition. New York : worth publisher. 2. OECD library (2011). Paris. Economic outlook 83. 3. Mohan, R (2006) Causal relationship between savings and economic growth in countries with different income levels. 4. Aghion, P ‘et al.’ (2009) When Does Domestic Saving Matter for Economic Growth? 5. Rafiq, S. (2012) saving and investment- the open economy. JU-WMBA. 07th July2012. Available from PPT slide. 6. www.investopedia.com 7. GUTIÉRREZ, M and SOLIMANO, A (2007) Savings, Investment and Growth in the Global Age: Analytical and Policy Issues.
