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Saving, growth and the current account

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ERSA / SASI Savings workshop August 2009 Daan Steenkamp Agenda Link between saving, investment and the current account Theoretical relationship between saving and ... – PowerPoint PPT presentation

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Title: Saving, growth and the current account


1
Saving, growth and the current account
ERSA / SASI Savings workshop August 2009
Daan Steenkamp
2
Agenda
  • Link between saving, investment and the current
    account
  • Theoretical relationship between saving and
    growth
  • The case of a small open economy
  • Macro implications of low saving
  • Sustainability of the current account deficit
  • Implications for macro policy

3
Accounting identities
  • In an open economy, domestic spending is the
    absorption of locally produced goods and services
    plus goods and services from overseas
  • Gross national product can also be expressed as
    the sum of expenditures by residents from
    national income
  • Setting the above equal, the current account
    balance is the difference between domestic saving
    and investment (private and public)
  • Current account balance is linked to net
    international capital flows
  • Re-arranging
  • Current account balance Domestic investment -
    domestic saving
  • Foreign financing of domestic investment generate
    claims on domestic assets.

4
Saving Growth Theory
  • Exogenous growth models
  • Saving supports higher investment and therefore a
    higher capital stock
  • Higher saving raises growth per worker only
    temporarily
  • Endogenous growth models
  • Higher saving raises per capita output and growth
    of per capita output
  • Do savings alone drive growth?
  • Positive impact of saving has, however, been
    shown to be contingent on complementary
    macroeconomic conditions and government policies
    that help channel savings into productive
    investment.
  • E.g. financial sector development, macroeconomic
    stability, openness to trade, prudent fiscal
    policies, investment in education, microeconomic
    reforms that support efficient resource
    allocation.
  • Can growth drive saving?
  • Life cycle models with liquidity constraints or
    endogenous models with habit formation suggest
    that growth could impact saving.

5
Open economy setting
  • If the economy is open and capital is mobile,
    foreign saving can be used to finance higher
    investment rate than domestic saving would allow.
  • If the return on foreign capital after
    depreciation gt cost of foreign borrowing
  • Foreign borrowing will raise the level of
    national income
  • Availability of foreign capital can also lower
    domestic interest rates
  • Impact of inflows of foreign saving on domestic
    saving is ambiguous
  • Lower interest rates reduce opportunity cost of
    current consumption, lower saving (substitution
    effect)
  • Lower interest payments (borrowers) or income
    (lenders), can increase or decrease saving
    (income effect)
  • Interest rate sensitivity of domestic saving an
    empirical question

6
High levels of domestic saving and investment are
associated with high levels of economic growth
6
7
Saving shortfalls raises growth volatility
7
8
Impact of increased savings on the economy
  • To increase domestic savings, domestic
    consumption will have to decrease
  • By substituting current consumption with future
    consumption, investment can increase, thereby
    increasing medium and long run productivity
  • The 5 level decrease in consumption initially
    results in total saving increasing by 20 which
    then allows investment to increase by 15

8
9
Increased investment increases exports and GDP
  • The increase in productivity promotes exports,
    improving our competitiveness, while imports are
    driven by the increase in investment.
  • It takes about 1 year for the impact of
    increased savings and investment to fully flow
    through to GDP
  • The rebalancing of growth from consumption to
    investment has a lasting positive impact on GDP

9
10
Inflows of foreign saving have helped raise
domestic investment
10
11
Domestic investment requires sustained foreign
financing which is dependent on macroeconomic
stability
Proportion of gross capital formation financed by
foreign capital
12
Low domestic saving relative to investment
manifests as a current account deficit
13
The current account deficit has been comfortably
financed
14
Capital inflows adding to stock of foreign
liabilities
15
Relying on foreign savings implies growing claims
on the income of domestic assets
15
16
An increasing proportion of foreign liabilities
are equity liabilities
Foreign Portfolio Liabilities Equity and Debt
17
Volatility is a greater problem if majority share
of capital is short term capital
17
18
Cost of capital
Declining costs of domestic borrowing
19
Cost of capital
Declining costs of foreign borrowing (before
crisis)
20
Sustainability of the current account
  • In the short term, the availability of foreign
    capital will depend on maintaining investor
    confidence.
  • This underscores the importance of sound macro
    management and political stability.
  • In the longer run, the efficiency with which
    saving is converted into investment is
    particularly important for the sustainability of
    the current account deficit and ensuring we
    benefit from drawing on foreign saving.
  • Servicing our foreign debt requires an increase
    in future exports or sufficiently high future
    real returns to domestic capital to service.
  • Microeconomic reforms that address constraints to
    growth and enhance the economys international
    competitiveness and flexibility are crucial.

21
Conclusion
  • By investing in resources, rather than consuming
    them, economies make a trade-off between present
    and future standards of living.
  • Investment is funded through savings (both
    domestic and foreign).
  • Fixed investment allows for more sustainable
    economic growth and improves international
    competitiveness.
  • In spite of low domestic saving, availability of
    foreign savings has supported higher domestic
    investment in South Africa.
  • This has, however, seen the current account
    deficit widen and foreign liabilities rise.
  • Foreign saving must be used to expand our ability
    to export and save in future.
  • A higher rate of domestic saving would reduce our
    vulnerability to the vagaries of investor
    sentiment.
  • It would help us develop a deeper and more liquid
    capital market, helping our companies expand.
  • Higher saving would also give South Africans a
    greater stake in the gains from domestic growth.
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