Economics 216: The Macroeconomics of Development

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Economics 216The Macroeconomics of Development

• Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.)
• Kwoh-Ting Li Professor of Economic Development
• Department of Economics
• Stanford University
• Stanford, CA 94305-6072, U.S.A.
• Spring 2000-2001
• Email ljlau_at_stanford.edu WebPages
  http//www.stanford.edu/ljlau

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Lecture 8Savings and Capital Accumulation

• Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.)
• Kwoh-Ting Li Professor of Economic Development
• Department of Economics
• Stanford University
• Stanford, CA 94305-6072, U.S.A.
• Spring 2000-2001
• Email ljlau_at_stanford.edu WebPages
  http//www.stanford.edu/ljlau

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Sources of SavingsHousehold Savings

• Household savings (reflects the trade-off between
  current and future consumption)
• Voluntary
• Involuntary--social security contributions,
  mandatory retirement fund contributions
• Quasi-voluntary--contributions matched by
  governments or employers
• Issues--fungibility (Are the various types of
  savings substitutes for one another, e.g., do
  social security savings offset voluntary savings
  dollar for dollar?)
• Investment in, appreciation of, and reduction in
  indebtedness on owner-occupied housing and
  consumer durables
• Other unrealized capital gains and losses
• Investment in human capital

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Sources of Savings

• Business savings (retained earnings, intangible
  investments)
• Government savings (budget surpluses, government
  capital expenditures (e.g., infrastructure and
  structures), inflation tax)
• Foreign capital (portfolio and direct
  investments, loans and aid)

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Savings and the Stage of Economic Development

• The importance of an agricultural surplus as a
  source of domestic savings in the early stage of
  economic development
• The demographic factor in the emergence of an
  agricultural surplus e.g. Japan had almost zero
  population growth between 1740 and 1840
• The United States had ample undeveloped land for
  agricultural expansion in the 19th Century
• Technical progress and economies of scale, e.g.
  mechanization of agriculture in 19th Century
  Japan and the United States

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The Role of Foreign Capital Allowing Domestic
Investment to Exceed Savings

• Foreign capital can jump-start the early economic
  development and growth process either as a
  substitute for or an augmentation domestic
  savings which is likely to be low at this stage
• Australia and the United States in the 19th
  Century benefited from foreign investment from
  Great Britain and other European countries
• China during its First Five-Year Plan period
  (1953-1957) received significant assistance from
  the former Soviet Union in the form of loans for
  the purchase of capital equipment
• Israel, South Korea and Taiwan have been major
  beneficiaries of U.S. aid in the early postwar
  period
• Singapore had a significant inflow of foreign
  investment in the early stage of its economic
  development in the mid to late 1960s

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The Evolution of Savings Rates in Chinese
Societies
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The Savings Rate and Real Output per Capita
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The Savings Rate and Real Output per
CapitaChinese Societies
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The Savings Rate and Real Output per CapitaEast
Asian Economies
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The Savings Rate and Real Output per
CapitaTaiwan
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The Savings Rate and Real Output per Capita

• Note that the developing countries typically have
  very low aggregate savings rates at low real GNP
  per capita
• Aggregate savings rates tend to rise rapidly with
  rising real GNP per capita
• After a certain level of real GNP per capita is
  reached, the savings rates tend to stabilize and
  remain approximately constant
• The slopes of the aggregate savings rate with
  respect to real GNP per capita during the rapidly
  rising phase appear to be quite similar

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The Relationship between Investment Rates and
Savings Rates
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Savings and the Rate of Interest

• Is the aggregate savings rate sensitive to the
  real rate of interest?
• The rate of interest ultimately reflects the
  marginal productivity of capital, which in turn
  depends on the efficiency (or the rate of return)
  of the investment
• Are savings deposits in financial institutions
  sensitive to the real rate of interest paid by
  financial institutions?
• Are savings deposits in financial institutions
  sensitive to the security of the depository
  institutions?
• Is deposit insurance, explicit or implicit,
  desirable? (questions of moral hazard on the part
  of both the depositors and the owners of the
  financial institutions)

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The Importance of Financial Intermediation

• Channeling savings to investments (to highest and
  best use?)
• Asymmetric information
• Maturity transformation
• Lumpiness of investments
• Pooling of risks
• Transactions costs
• Monitoring costs
• Lack of alternative investment instruments for
  savers
• Implicit and explicit deposit insurance
• Moral hazard
• On the part of the owners of the financial
  institutions
• On the part of the borrowers, large and small
• Informal credit markets (the lack of anonymity
  which limits moral hazard)
• Mutual credit associations
• Grameen banks

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The Impact of Inflation

• Chronic inflation discourages savings at
  financial institutions unless the rate of
  interest is indexed to inflation
• Inflation increases the risks of long-term fixed
  investment (unpredictability of future relative
  prices, macroeconomic conditions and demand)
• Inflation encourages recklessness (moral hazard)
  on the part of the borrowers, especially if the
  rate of interest is fixed in nominal terms
• Inflation generally means a higher variability in
  prices, which in turn causes higher variability
  in profits (and losses) and hence a higher loan
  default rate
• Inflation may thus discourage lending even though
  the real rate of return, based on the price
  index, may be positive

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The Possibility of Under- and Over-Investment

• Under-Investment
• Lumpiness (economies of scale and size of market)
• Lack of infrastructure
• Lack of coordination
• Non-appropriability of the external
  benefits--spillover effects
• Government actions may be needed
• Over-Investment
• Low or subsidized cost of funds (domestic or
  foreign)
• Non-productive investments
• Herd instinct
• Winner-Take-All type situations

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Why Do Savings Rates DifferAcross Countries? (1)

• Lags in adjustment--the permanent income
  hypothesis of Milton Friedman, habit formation
• Differences in the real rates of return
• Differences in the degree of stability of the
  macroeconomy, e.g., the rates of inflation
  (inflation discourages financial savings)
• Differences in the stability of the financial
  system and the currency
• Differences in the security of the depository
  institutions
• Differences in population characteristics, e.g.
  the demographic structure (age distribution,
  dependency ratio), life expectancy, morbidity
  rate, mortality
• Differences in the social welfare system and
  institutions--pension and retirement, health
  care, and unemployment
• Differences in the availability of insurancethe
  degree of incompleteness of markets, the need for
  self- or mutual insurance
• Differences in the cost/burden of social
  services--education, housing, medical care

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Why Do Savings Rates DifferAcross Countries? (2)

• The availability of household credit for consumer
  goods and for housing (the cash-in-advance
  constraint)
• The availability of consumer goods
• The bonus wage system (lumpiness of payment and
  money illusion)
• Differences in preferences and tastes, social
  norms of consumption and cohort-specific
  historical experience (e.g., Americans who lived
  through the Great Depression do not like to
  borrow the social expectation for ceremonial
  expenditures--birthdays, weddings and
  funerals--in developing economies)

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Precautionary Savings as Self-Insurance Given
Incompleteness of Markets

• Precautionary savings are motivated by the
  existence of uncertainty and risks (e.g., death,
  illness, unemployment, bank failure, fire, poor
  harvest, expropriation, inflation)
• Existence of risks does not in itself necessarily
  imply a higher savings rate to the extent that
  actuarially fair insurance is available as a
  hedge against the risks
• Precautionary savings are necessary because
• Not every risk can be insured
• Not every insurable risk can be fully insured
  (the problem of moral hazard) or fairly insured
• Thus the necessity of self-insurance
• The more incomplete the markets, the higher the
  level of precautionary savings, other things
  being equal
• Markets are least complete in developing economies

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Savings as a Flow and Savings as a Stock

• Savings as a flow is whatever is left over from
  current real output that is not consumed
• Savings as a stock refer generally to the level
  of financial savings, or even more narrowly
  savings deposits, at a given point in timeit is
  the cumulative result of the annual flows of
  savings (and dis-savings) over time

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The Savings Rate and theDistribution of Income

• Hypothesis The savings rate rises with increases
  in the degree of inequality of income
  distribution
• Typical assumptions of models of economic growth
  
• capitalists save and workers consume
• Profit rates, and hence, business savings, tend
  to rise with concentration
• The initial distribution of capital (human and
  non-human) and its evolution over time also
  matter
• However, diversions by and leakages from wealthy
  households are common
• Overseas investments
• Imports of luxury consumption goods
• Capital (foreign exchange) control, import
  control, credit rationing and direct government
  intervention may be necessary

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The Savings Rate and theDistribution of Income
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The Savings Rate and theDistribution of Income
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The Question of Embodiment

• Is technical progress embodied in new fixed
  investment (capital goods)?
• Is the hypothesis empirically testable?
• What are the implications of embodiment?

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The Independence of the Steady-State Rate of
Growth from the Savings Rate

• R. M. Solow (1956)
• The importance of Inadas second condition--the
  marginal product of capital approaches zero as
  the quantity of capital (relative to labor)
  approaches infinity
• If the marginal product of capital has a lower
  bound, then the steady-state rate of growth may
  depend on the savings rate (Rebelo (1991))