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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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saving growth and the current account

Saving, growth and the current account

ERSA / SASI Savings workshop August 2009

Daan Steenkamp

agenda
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

accounting identities
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.

saving growth theory
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.

open economy setting
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 > 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

impact of increased savings on the economy
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%

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increased investment increases exports and gdp
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

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slide11
Domestic investment requires sustained foreign financing which is dependent on macroeconomic stability

Proportion of gross capital formation financed by foreign capital

an increasing proportion of foreign liabilities are equity liabilities
An increasing proportion of foreign liabilities are equity liabilities

Foreign Portfolio Liabilities: Equity and Debt

cost of capital
Cost of capital

Declining costs of domestic borrowing

cost of capital19
Cost of capital

Declining costs of foreign borrowing (before crisis)

sustainability of the current account
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 economy’s international competitiveness and flexibility are crucial.

conclusion
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.