Saving, growth and the current account. ERSA / SASI Savings workshop August 2009. Daan Steenkamp. 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
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ERSA / SASI Savings workshop August 2009
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
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:
Current account balance = Domestic investment - domestic saving
Foreign financing of domestic investment generate claims on domestic assets.
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.
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 > 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
Proportion of gross capital formation financed by foreign capital
Foreign Portfolio Liabilities: Equity and Debt
Declining costs of domestic borrowing
Declining costs of foreign borrowing (before crisis)
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 economy’s international competitiveness and flexibility are crucial.
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.