Savings: a Social Vice?
Keith Rankin, 31 March 1998
I recently wrote about the contradictions of the government's mooted Code of Social and Family Responsibility (Family Responsibility: to Save or to Spend) suggesting that it is really part of a code of self-reliance which contains contradictory elements; namely the message for parents to spend more on their children's welfare while also saving more for their retirement. An article in The Economist (21 March 1998) adds a wider macroeconomic view to this issue of the social benefits or otherwise of saving and spending. The article - "The Vice of Thrift" - notes the vastly better economic "performance" of spendthrift USA compared to miserly East Asia.
The basic idea that savings is the essential driving force of economic growth derives from "Old Growth Theory". It attributes growth to "fixed capital"; infrastructure, factories and machinery. It sees the amount of investment in such capital goods as being determined by household decisions to save or not to save. It assumes that miserly peoples will produce more fixed capital and less of the products made possible by fixed capital.
Therein lies the rub; miserly societies' activities are driven not by demand but instead by the supply of savings. Such societies do not invest their savings in the kinds of fixed capital goods that lead to good economic performance, because the demand for the consumer goods (wage goods) made by these capital goods is too low. Not surprisingly, such nations will produce many of the wrong kinds of fixed capital investment. That is the essence of the Economist's finding.
Unfortunately, The Economist doesn't go far enough. The fact is that investment capital will always be available in any society with properly managed capital markets. Under such conditions, returns to savings rise when there are good investment outlets for savings. It is investment that drives savings, and not savings that drives investment. Sometimes investment can also create "forced savings" which is generally thought to mean more inflation (or less deflation). This view of forced savings equating to inflation is out of fashion to some extent, because it is a view that an inflationary environment improves a nation's growth rate.
More frequently, however, increased demand-driven investment means better utilisation of unused savings, the most important of which is the employment of unemployed labour. Indeed unemployment is one consequence of excess savings. In Asia's case in the 1980s and early 1990s, that unemployment was largely exported, eg to Europe.
Raising the supply of savings in advance of investment demand leads to an unstable world economy. Inasmuch as the excess savings are in the form of high profits chasing high returns, these savings flow rapidly around the world in search of the best deal. This huge flow of excess savings destabilises the world economy, ensuring that savings tied up in any particular investment project for too long become very risky. The instability of the flow of excess savings creates a relatively high demand for investment outlets with a short pay-off; this is what is known to lay persons as "speculation" and euphemistically known in the trade as "arbitrage". Such savings tend to seek out speculative returns in just a few highly locations perceived at the time to be highly remunerative. The result is high short term capital gains on those speculative investments. Indeed, the more unstable the process gets, so the more unrestrained savings seek out speculative returns in fashionable locations.
(For a historical perspective of this issue of financial instability, see Charles P. Kindleberger's Manias, Panics and Crashes, 3rd. edition. The book is substantially reviewed by Gregory Moore in the History of Economics Review 27, 1998.)
In a properly managed market economy, everything is driven by demand, including the growth process. High growth should only take place if people demand high growth in preference to the alternatives. That means that a market economy is driven by spending, which means that if we spend less it is an indication that we want growth to slow down, not the speed up. A well-functioning market economy will always provide investment capital when it is genuinely demanded, regardless of the rate of savings. Fixed capital is demanded only when the consumer goods and services made possible by that capital are demanded. As The Economist notes, that's what has been happening in the USA, and as a result the quality of American investment far exceeds the quality of recent Asian investment.
America does have problems, big problems, but they derive from a longstanding social belief in the virtues of inequality, self-reliance and conspicuous consumption, and not from a low savings rate. America gets what it demands. From the point of view of the rest of the world it demands too much; that's another problem.
Miserly household behaviour - earning high incomes while spending little - does not generate growth and is not done in order to generate growth. Rather, it is a strategy common in an unstable economic environment whereby security-conscious people are seeking to get larger shares of what they fear will be smaller future economic cakes. That strategy simply reinforces the dangers of the environment that breeds it; it is an example of unsocialised economic behaviour where persons look to their own advantage by disadvantaging others. The sustainable and more stable approach is that people not wanting to spend much should reduce their incomes rather than raise their savings, gaining wellbeing from leisure pursuits, relaxed lifestyles and spending time with their children.
Rankin File | 1998 titles