National and the World Economy Why have saving rates declined since the early 1970s? Some reasons, and the policy measures needed to stimulate saving Bijan B. Aghevli and James M. Boughton

sving is critically important to help main- Determinants of saving to the working age population. tain strong and sustainable growth in the There is no easy explanation for the With declining birth rates and increases in world economy, provide external adjustment, pervasive decline in saving rates around the life expectancy, the average age in most and ease the international debt problem. world, but an important contributing factor in industrial countries has been rising during the Over the past two decades, saving rates have many countries has been the decline in past two decades. In most cases, this rise in fallen sharply in many industrial and develop- government saving reflecting expansionary average age has taken the form of a decline ing countries, as have capital accumulation budgetary policies. That decline, particularly in the youth-dependency ratio. Although the and growth. Moreover, the substantial diver- in some of the larger industrial countries, has ratio of the elderly to the total population has gence of saving rates among countries has been the most significant component of the also risen, the ratio of the elderly to the contributed to the emergence of large current drop in national saving rates. In addition, working-age population has been fairly stable account imbalances, especially among the private saving in many countries has also in most industrial countries. Thus, the effect major industrial countries. fallen below the levels that prevailed in the on saving of the increasing average age has The ratio of aggregate saving to GNP in 1960s and early 1970s. The reasons for the so far been small. During the 1990s, shifts in industrial countries fell by about 6 percentage decline in private saving are complex, but the age structure are likely to affect saving points from the early 1970s through the early possible explanations include shifts in the age positively, but this trend will be sharply 1980s, before stabilizing around 20 percent structure of the population, indirect effects reversed in the following decade and thereaf- in the latter half of the 1980s (see Chart 1). of fiscal policies, increases in wealth relative ter. The even larger decline in developing coun- to current income, declining nominal and real Private saving is influenced by tries (8 percentage points) almost completely rates, and deregulation of financial through several channels. First, if there are reversed the substantial rise in saving rates markets. While it is not possible to draw any unemployed resources in the economy, in- in those countries that occurred in the late firm conclusions about which of these factors come will rise and will generate additional 1960s and early 1970s. Quite naturally, this has been most important, each seems to have private saving. Second, a decline in govern- trend in saving has become a major source played some role. ment saving resulting from a tax cut could of concern, prompting both academics and Demographic factors affect aggregate sav- well give rise to the expectation of a policymakers to examine the main factors ing rates because a major motivation for compensating tax increase in the future, responsible for this decline, the appropriate saving is to smooth over time inducing taxpayers to increase current saving rate of saving, and the efficacy of policies to on the basis of anticipated lifetime income. and to offset, at least partially, the decline in stimulate saving. In general, young people and retired elderly government saving. Third, a decline in persons save relatively little (see article by government saving could even discourage The article is based on a more detailed study prepared Steven Webb and Heidi Zia in this issue). The private saving to the extent that it shifted the by the authors with Peter Montiel, Delano Vil- aggregate saving rate falls in response to an tax burden from present to future genera- lanueva, and Geoffrey Woglom, The Role of increase in either the youth-dependency ratio tions. On balance, a decline in government National Saving in the World Economy: Recent saving is likely to be partly, although not fully, Trends and Prospects, published as Occasional (i.e., the ratio of under-20 age group to the Paper 67, IMF, 1990. 20-64 age group) or in the ratio of the elderly offset by an increase in private saving.

2 Finance & Development I June 1990

©International Monetary Fund. Not for Redistribution In most industrial countries, the of clude: relaxation or elimination of ceilings on barely exceed subsistence, especially in household wealth has increased substantially interest rates; the opening of and countries with unequal income . because of the rise in the value of equities and capital markets to small savers; relaxation of In countries in which a large portion of housing that has taken place during the 1980s. controls on international capital markets; and aggregate consumption is at subsistence The rise in wealth is likely to have diminished expansion of the range of activities permissi- levels, private savers would find it difficult to the need for saving out of current income. ble to banks and other financial institutions. reduce consumption in response to, say, This effect has been particularly prominent While these reforms have been aimed mainly increases in interest rates. Another factor is in Japan, where a near quadrupling of the ratio at strengthening the mobilization and alloca- that a relatively large portion of households of household net wealth to GNP during tion of financial resources, and have thereby in developing countries derive their incomes 1982-87 is estimated to account for about improved the efficiency with which from agriculture, where incomes are subject three quarters of the total decline (of 3.2 are used, they may have also contributed to to large fluctuations owing to variations in percentage points) in the saving rate. In the the observed decline in national saving rates. world of agricultural commodities and United States, Fund staff estimates indicate For example, the increased availability of to climatic conditions. This uncertainty is that the rise in the ratio of wealth to income finance for purchases of housing and expen- compounded by higher risks of disability, by could explain a 2 percentage point decline in sive consumer durables has obviated the need macroeconomic instability, and by the less the personal saving rate during the last two for households to save in preparation for important role of income taxation in develop- decades. making large down payments for such pur- ing countries. The net effect of a change in the real chases. Adequacy of global saving on saving is theoretically am- Developing countries biguous. A rise in the interest rate will Is the level of saving too low in the world increase future income and wealth of house- The decline in aggregate saving in devel- economy? An important implication of neo- holds, prompting an increase in current oping countries conceals a wide variety of classical economic theory is that changes in consumption. But a higher rate of interest experiences among country groups. Most the saving rate affect the level of output but may encourage current saving by increasing notably, countries with debt-servicing difficul- not the long-run growth rate. An increase in the level of future consumption that is ties experienced substantial declines in saving saving increases the ratio of the capital stock associated with a given level of current rates, as substantially higher interest pay- to the given labor supply and initially raises saving. Empirical work suggests that, on ments on external debt and adverse move- the growth rate of output per capita. With balance, the generally modest changes in real ments in the terms of during the early diminishing returns to capital, however, the interest rates that have occurred in recent 1980s reduced national income. Generally, growth .rate of per capita output eventually years have probably had only a very small net saving rates of low- countries have falls back to the underlying growth rate, effect on saving. been as much as 9-10 percentage points which is determined by the rate of technologi- Saving rates may also respond to changes above those of high-inflation countries during cal progress. in the rate of inflation, although the net effect the 1980s. Saving rates also have varied In this framework, an increase in the saving of these changes during the 1970s and 1980s directly with the level of development, as rate will always raise the level of output per has again probably been small. An increase measured by the level of per capita national capita, but not necessarily of consumption per in the inflation rate, even when accompanied income: the higher the per capita income, the capita. Accordingly, a case for raising the by a commensurate increase in the nominal higher the saving ratio. saving rate can be made only if myopic interest rate, may erode the real value of Fundamental motives for saving in develop- behavior on the part of the present generation household wealth and raise the saving rate. ing countries are similar to those operating could put excessive weight on current con- A higher rate of inflation, however, is in industrial countries. However, the environ- sumption and make succeeding generations generally associated with higher uncertainty ment in which saving decisions are made in worse off. The appropriateness of individuals' on the rate of return, which could have a developing countries is quite different from saving decisions may also be questioned if depressing effect on the desire to save. In that in industrial countries. Most obviously, there are distortions arising from government addition, the effect of inflation on saving will household income is much lower in the policy and rigidities. also depend on the country's tax system. For developing countries. A large number of The case for raising the saving rate is example, in countries where at least some households are likely to have incomes that strengthened considerably if the long-run interest expenses are deductible (e.g., the growth rate of the economy is directly United States), a higher rate of inflation may Chirtl influenced by the saving rate. For example, lower the real after-tax rate of interest and Gross national saving rates: if capital accumulation leads to increases in industrial and developing encourage borrowing, thus lowering saving. countries. 1965-88 labor productivity and to improvements in the Changes in corporate saving may also be quality of the labor force, then a rise in the offset, in part, by changes in household saving rate could lead to a permanently higher saving. For instance, an increase in corporate growth rate and not just to a higher level of saving generally induces an increase in output. Other sources of growth are benefi- company share prices; hence, shareholders' cial (effects that are external to wealth increases, leading to a decline in the firms making the decisions) household saving. Nonetheless, this effect associated with research and development, on private saving is unlikely to be large specialization of production, international enough to completely offset the rise in trade, and public investment in social infra- corporate saving. structure. If these factors are important, then During the last two decades, substantial clear policy prescriptions emerge for subsi- financial reforms have been implemented in dies to investment activities that involve such Source OECD. National Accounls. the industrial countries. These reforms in- externalities: if firms do not get the full

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©International Monetary Fund. Not for Redistribution Ch»rt2 foreign assets, the country would ensure that Gross national saving, gross domestic investment, and current account balance, 1965-88 it is in a position to finance the subsequent rise in consumption and the corresponding current account deficit, hi this case, the country would be ill advised to reduce its surplus by reducing saving—which would lower growth at home and abroad—or by undertaking inefficient domestic investment. Also, if domestic investment in a country was more productive, owing, say, to its resource endowments, than in other countries, it would be desirable for the country to run a current account deficit. There are, however, circumstances when a large and persistent current account imbal- ance could be an indicator of underlying problems. If private saving is too low because of tax or other public sector distortions, a country may be able to sustain its consump- tion through reliance on foreign saving. If unchecked, a rapid rise in the ratio of external debt to GNP could eventually create solvency Source OECD u.1. . IMF World Economic Outlook, am) IMF slaff estimates. problems and necessitate abrupt and costly adjustment. Alternatively, if tax and other benefit of their new , government countries since the early 1980s have been distortions result in an outflow of domestic subsidies can increase both growth and associated with the emergence of large and saving, domestic investment could decline to welfare. The practical problem lies in identify- persistent external imbalances among these a suboptimal level. Similarly, the government ing the externalities and estimating the countries. Chart 3 depicts a very close can resort to foreign borrowing to alleviate warranted subsidies. correlation between domestic saving and pressures on domestic interest rates. This Notwithstanding the preliminary stage of investment—both long-term trends and short- situation, however, cannot be sustained theoretical and empirical work on models that term variations in the aggregate saving rate indefinitely. Eventually, a high level of gov- explain the links between saving and growth, are closely tracked by domestic investment ernment consumption financed by the accu- these models have important implications for (see also article by Tamim Bayoumi in this mulation of foreign liabilities could undermine assessing the adequacy of saving. To the issue). Shifts in the aggregate current ac- market confidence, resulting in sharp move- extent that there are external benefits count balance also appear to be correlated, ments in exchange and interest rates. associated with the investment process, the albeit weakly, with the broader swings in returns available to private savers may not saving. Policy options fully capture the returns to investment. While An important point of debate among The most direct way to raise national the accumulation of physical or financial assets academics and policymakers alike has been saving is to increase government saving. Such is important for , the role of whether current account imbalances repre- an increase can be achieved through a education, expenditure in research and devel- sent a problem and, if so, how they could be reduction in government consumption and opment, and other nonconsumption expendi- dealt with. On the one hand, it is argued that, transfers or an increase in taxes. These tures that enhance future productivity should to the extent that current account imbalances measures are likely to have different impacts not be ignored. In addition, in an open reflect different rates of return to investment on private and, therefore, national saving. economy, the distinction between saving and and differing saving rates across countries, An increase in taxes will lead to a partially investment becomes crucial: policies to pro- they would not necessarily pose a problem. offsetting decline in private saving. This offset mote saving may have little effect on growth On the other hand, large and persistent could be exacerbated if the increase in taxes if the factors fueling growth are associated current account imbalances could eventually falls on income rather than on consumption. primarily with domestic investment, unless lead to sudden and unpredictable changes in Consequently, a given reduction in govern- domestic saving can be channeled into pro- macroeconomic policies—or in variables such ment consumption is likely to have a larger ductive uses. as exchange rates, interest rates, and prices impact on national saving than an equivalent This last consideration assumes greater of financial assets—and thereby induce large increase in taxes. significance as the degree of international adjustment costs. National saving can also be affected by the capital mobility increases. In a world of high Generally, a current account imbalance composition of government consumption. capital mobility, increases in saving may lead could be benign so long as individuals' Certain government transfers—such as pub- to capital outflows and thus to small increases decisions to save and invest are made in the lic pensions, benefits, health in domestic investment. While national wealth absence of significant distortions or rigidities care, housing allowances, and student will still increase, the full benefits of domestic in the system. For example, if the high rate aid—tend to reduce private saving directly. investment are no longer captured by the of saving in a given country is attributable to Decisions on the proper level of government country doing the investing. demographic factors that are expected to be programs clearly cannot be made solely on Changes in external balances reversed over time, it would be natural for the basis of their impact on national saving. the country to run a current account surplus Nevertheless, concerns about national saving Shifts in saving patterns of major industrial for an extended period. By accumulating could justify raising government saving to

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©International Monetary Fund. Not for Redistribution compensate for the adverse effect of public political) costs, then undue reliance may be investment exist, financial repression may programs on private saving. In the specific placed on deficit financing in response to such induce private individuals to hold their assets case of public pensions, for example, it might shocks. In addition, since the public sector in abroad. In the presence of such capital be possible to move from a "pay as you go" the majority of developing countries is a net outflows, domestic investment opportunities system to some form of funding of public debtor to the domestic financial system, the will go unexploited unless foreign financial pensions. Further, to the extent that demo- maintenance of interest rates below equilib- intermediaries are willing to lend to domestic graphic factors may result in social security rium levels lowers public borrowing costs, at firms. Financial reform measures can obviate cash flow surpluses that are expected to be the expense of distorting the composition and the need for this external financial intermedia- reversed, it is important that these surpluses possibly the level of private saving. tion by changing the composition of national be held in reserve against future payments. Fiscal restraint in developing countries saving away from the accumulation of foreign Some countries may be able to reduce typically takes the form of the curtailment of financial assets toward that of domestic distortions affecting saving behavior by modi- current expenditures, improved revenue per- assets. fying the structure of the income tax. An formance (for example, through more realis- An appropriate policy mix for developing important source of distortion in many coun- tic pricing for the output of nonfinancial public countries to promote saving would be one tries is double taxation of income from capital: enterprises, increases in taxes, and improved that pursues the objective once at the corporate and once at the personal tax collection), and of a rationalization of the through relatively tight fiscal policies while income level. Another source of distortion public investment program. These policies ensuring adequate levels of private sector arises because of incomplete indexation of are primarily intended to bring the growth of credit within the framework of ceilings on income taxes. The tax codes of most aggregate demand in line with the growth of total credit expansion. The fiscal measures countries levy a tax on nominal, rather than productive capacity, thereby diminishing the adopted, in turn, should avoid excessive real, capital income. As a result, an increase country's claims on external resources and reliance on the taxation of income from capital in expected inflation accompanied by an equal easing domestic inflationary pressures. At the or curtailment of public consumption expendi- increase in the nominal interest rate lowers same time, to the extent that such fiscal ture that fosters human capital formation, or the after-tax real return to saving. The high tightening takes the form of reduced current of public expenditure on productive invest- rates of inflation during the late 1970s and spending and increased revenue collection, ment projects that are complementary to early 1980s, which made after-tax real these policies also raise public sector saving private investment. The most important returns negative in most of the industrial directly. desideratum for fiscal policy, however, is that economies, may have contributed to the A key element of efforts to promote the the fiscal adjustment be credibly viewed as decline in saving. efficient allocation of savings in developing permanent, rather than as a set of stop-and- Developing countries. During the 1970s, countries is the pursuit of realistic interest go measures. Finally, the avoidance of saving in industrial countries made an impor- rate policies in the context of liberalized periodic real exchange rate overvaluation can tant contribution to the financing of invest- financial markets. The objective of adjusting make an important contribution to fostering ment in developing countries. In recent interest rate policy is to allow interest rates a macroeconomic climate conducive to saving years, however, not only has the total supply on both the assets and liabilities of the and investment. • of saving declined in industrial countries, but domestic banking system to reflect market also the emergence of the debt crisis in the conditions, either by liberalizing controlled developing countries has resulted in a re- interest rates completely (as in Argentina and duced flow of external funds for developing Chile) or by gradually phasing them out (as countries. As a result, an increase in domestic in Indonesia, the Republic of Korea, and Sri investment that is required to restore ade- Lanka). These changes in domestic interest quate levels of economic growth in developing rates are in some cases combined with countries must be financed largely through financial sector reforms intended to increase Bijan B. Aghevli domestic saving. Consequently, policies to the menu of assets available to private savers from Iran, is Senior Advi- sor in the Fund's Research raise both public and private saving and and to improve the efficiency of the domestic Department. He holds a banking system. Such policies and reforms investment are critical for the growth and PhD from Brown Univer- adjustment efforts of developing economies. are intended not just to raise the overall level sity and taught at the Lon- In many developing countries, severe of private saving, but also to channel saving don School of Economics. administrative problems impair tax revenue away from other destinations (such as infor- collection, though experience varies consid- mal financial markets or abroad, in the form erably across countries. Where these prob- of ) and toward the domestic lems are prevalent, tax evasion is common, banking system or other organized markets, through which it can most efficiently be and sources of tax revenues that require James M. Boughton greater administrative resources (e.g., in- allocated to domestic investment. a US citizen, is an Advisor come taxes) are relied on less intensively The solution of the capital-flight problems in the Fund's Research De- than others that are easier to administer that have plagued many heavily indebted partment. He holds a PhD (e.g., trade and excise taxes). More impor- developing countries in recent years requires from Duke University. He tant, administrative problems may reduce that domestic savers find the holding of was a Professor of Econom- public sector saving in many circumstances. domestic assets—both physical and finan- ics at Indiana University When declines in public sector saving cannot cial—to be remunerative. Unless investment and also worked at the be offset by increases in tax revenue, the in physical capital at home is profitable, even OECD. burden of adjustment falls on public consump- a well-functioning financial system would tend tion. If reductions in public consumption are to place accumulated domestic savings abroad. subject to increasing marginal (economic or But, even if opportunities for domestic

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