Title: Economics 216: The Macroeconomics of Development
1Economics 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
2Lecture 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
3Sources 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
4Sources 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)
5Savings 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
6The 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
7The Evolution of Savings Rates in Chinese
Societies
8The Savings Rate and Real Output per Capita
9The Savings Rate and Real Output per
CapitaChinese Societies
10The Savings Rate and Real Output per CapitaEast
Asian Economies
11The Savings Rate and Real Output per
CapitaTaiwan
12The 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
13The Relationship between Investment Rates and
Savings Rates
14Savings 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)
15The 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
16The 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
17The 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
18Why 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
19Why 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)
20Precautionary 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
21Savings 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
22The 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
23The Savings Rate and theDistribution of Income
24The Savings Rate and theDistribution of Income
25The Question of Embodiment
- Is technical progress embodied in new fixed
investment (capital goods)? - Is the hypothesis empirically testable?
- What are the implications of embodiment?
26The 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))