Tuesday, November 3, 2009

Growth leads to savings, not vice-versa

Fast-growing countries, like currently China, have very high savings rates. Data indicates that causality runs from growth rates to savings, and not the reverse. In theory, this is puzzling. Such high growth rates originate in rapid productivity improvements. This leads to high returns for capital and thus one should see high investment (and savings). However, returns for savings in such countries are very low. Why are people savings so much then?

Yi Wen finds one way to justify this: precautionary saving. We know that whenever there is a motive for precautionary savings, this can be rewarded with interest rates below the discount rate. And this is triggered by borrowing constraints. And it is well known that the Chinese financial sector is still severely underdeveloped.

The actual mechanism at play is obscure to me. The paper reasons that when permanent income increases, it is savings that increase instead of consumption, because of the borrowing constraint. The only way I can see this happening is when the uncertainty increases faster than incomes, or if utility is twisted in some way. But I do not seem to see either. While the author claims to have made a model that is tractable and analytically solvable, it does not appears to help in any way to understand what is going on. And Yi Wen does not seem to offer any explanation either.


Vilfredo said...

Does Yi Wen know about this post? Does he(?) have some intuition to offer?

Forex Signals said...

Yes, China's savings are growing, but 80% of their population is still deadly poor...