Economics 216: The Macroeconomics of Development - PowerPoint PPT Presentation

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Economics 216: The Macroeconomics of Development

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Title: Economics 216: The Macroeconomics of Development


1
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

2
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

3
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

4
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)

5
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

6
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

7
The Evolution of Savings Rates in Chinese
Societies
8
The Savings Rate and Real Output per Capita
9
The Savings Rate and Real Output per
CapitaChinese Societies
10
The Savings Rate and Real Output per CapitaEast
Asian Economies
11
The Savings Rate and Real Output per
CapitaTaiwan
12
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

13
The Relationship between Investment Rates and
Savings Rates
14
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)

15
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

16
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

17
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

18
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

19
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)

20
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

21
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

22
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

23
The Savings Rate and theDistribution of Income
24
The Savings Rate and theDistribution of Income
25
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?

26
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))
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