Dose Saving Help A Country To Grow Faster Economics Essay
Dose saving help a country to grow faster? Theoretically, for a country to grow faster and consistently in long-run, the country must have invested more in their capital stock. Whereby, in economics term, capital stock is defines as factors of production such as factories, machinery, equipment that produce more goods and services (John Eatwell, 1987). For a country to achieve such high level of investment in replacing their old capital stock for greater nation productivity, the country should have save enough capital resources for their investment. Thus, saving play a crucial rule in a country��s development and growth. This is supported by the earlier study (Lewis, 1955) about the relationship between national saving and economic growth. According to this study, saving which lead to capital accumulation of a country would consequently lead to real income growth. In contrast to the general views that argue, it is consumption that drives the economy. Whereby, consumer spending plays the largest part in gross domestic product (GDP) - a measurement of the economy production. This makes the relationship between saving and consuming contradicting to each other. Whether should a country emphasize in saving more or spending more?
Saving can be defined as income or excess capital resources which are not consume now, but accumulate for the better future consumption. Understanding the relationship between saving and economic growth rate is crucial, as it helps country to formulate policy which maintains healthy level of national saving to promote economic growth and ultimately improve the overall standard of living for that country. As today��s saving increases a country capacity to produce more goods and services in the future. Therefore, saving can helps to increase the standard of living for the future generations.
As an open economy country like Malaysia, the source of saving often can be obtained from two different ways: either from domestic national saving or from foreign saving. Due to the reason that Malaysia is a developing country, whereby, domestic savings is usually insufficient to meet the total investment the country made. Foreign saving especially foreign direct investment is needed to fill up the gap between the total saving and investment a country has made. A question then arise, whether foreign direct investment as a foreign saving is a reliable source of saving that will eventually contribute to the economic growth. Some studies (Thu Thi Hoang, 2010) (Hete?, Moldovan, & Miru, 2009) showed that foreign direct investment is positively correlated to the economic growth on the host country. In contrast, some studies (Singer, 1950) however showed different result that stated foreign direct investment does not benefit the host country, in fact, it even lower the host country economic growth rate. This again shows another inconclusive result for the relationship between foreign direct investment and economic growth rate. Thus, this paper will examine the relationship between these three variables: National saving, Foreign Direct Investment, and Gross Domestic Product.
Defined Gross Domestic Product
Gross Domestic Product (GDP) is one of the most common macroeconomics method uses in measuring the size of the economy of a country. According to The Economist glossary, GDP is defined as the total of value of all final products being produced in a country for a given period. As every dollar of product that being produced is equal to every dollar the producers made, thus GDP can be said is equivalent to the national income. There are millions of goods and services included in the GDP, whereby it can classified as the following equation:
Y = C + I + G + NX (1.1)
Y denotes as the GDP, C, indicate household or private consumption, I, indicate as private sector investment, G indicate the total government spending, and lastly NX indicate net export. In general GDP can be representing for any time period as the sum of these components. The GDP data can be presented in two different way: nominal GDP verses real GDP. Nominal GDP is defined as the current dollar or raw GDP data without being adjusted or deflated by any inflation variable. Taking in the inflation effect, where one dollar today is better than one dollar in the future. Real GDP that being defined as the constant dollar which being deflated by the inflation factor. The use of real GDP can result in better measurement in doing econometric measurement.
Malaysia being one of the high saving country which able to maintain gross national saving rate above 30% of GDP since 1980s (Chen et al., 2008). The high level of national saving in Malaysia helps to support the country domestic investment and in turn promote consistency high grow rate of GDP. Being one of the fastest growing economies countries, Malaysia has a remarkable growth rate from the late 1980s until the first half of 1990s. The average GDP growth rate from 1970 until 2004 was about 7%. The World Bank (1993) also revealed the role of saving in economic development of a country. According to the survey, those countries that have higher saving rate have grown faster than countries that have lower saving rate. Motivated by this statement, this paper has come out with a hypothesis that high rates of saving in Malaysia contributed to their long run economic growth.
Defined Gross National Saving
According to the (UNITED States. General Accounting Office, 2001), the definition to the National saving is the sum of saving by households, businesses, and all levels of government. In other words, national saving can be define as the process whereby individuals, businesses, and governments of a particular country set aside part of their income in order to accumulate assets for the purpose of generating larger flows of income in the future. Just as individuals must decide how much of their income to save and how much to spend, business firms must decide how much of their profits to pay out as dividends and how much to retain for better reinvestment, and government must decide how much to tax and how much to spend. Collectively, all these three points out the nation��s rate of saving.
Defined Foreign Direct Investment
Foreign direct investment, FDI, is defined as foreign capital inflows whereby foreign companies come in to the domestic country to invest in their expansion of their subsidiary. The effect of FDI is not just simply transfer of resources to a domestic country but the firm also remains their acquisition of control of their assets. Since 1990s, one of the main source contributing to Malaysia high rate of economy growing is FDI. Besides creating more employment, FDI also contribute in transfer of technology which help developing country like Malaysia to expose to more advance technology production and efficiency in management
1.2 Research Objective:
The research objective of this paper is to add contribution into the existing researches of the topics related to the relationship between saving and economic growth. This study will explain in what degree does saving led to the long term economic growth in Malaysia. By choosing time series features, through multiple regression, this paper has break out the saving component into domestic and also foreign saving (FDI in particular). As this study adds in FDI as another supportive variable in the study model, this will provide a better explanation on the role of each saving component in contributing to the overall economic growth. Given that Malaysia is an open economy that often financed their domestic investment through domestic and foreign saving. Thus, the variable of FDI should not be omitted.
1.3 Research question:
The relationship between saving and GDP is unclear and contradicting with the general view that consumption drive the economy growth. Besides, since the foreign saving can substitute for the domestic saving to fill in the gap between domestic saving and total investment the country made. Question like: is domestic saving really matter? Need to be address in this study to test out which variable is more reliable source of saving that the country should adopt.
This study is organized into five chapters. The following chapter two will be discussion on literature review. Then the chapter three will be discussing about the data and methodology of this study, by using multiple regression to test the relationship between variables. The forth chapter will be the result discussion. Lastly, chapter five will be the conclusion where recommendation and limitation will be suggested.
2.0 Literature Review
One of a classic theoretical perspectives in saving lead growth theory, is started by Mill- Marshall- Solow (1956) view. The theory assume that all saving is automatically transfer to investment, and later translated into higher output growth under wage- price flexibility and full employment. It perceived that higher saving precedes and causes economic growth through increase of investment as a source of capital accumulation for a country.
Carroll and Weil (1994), habits cause consumption to respond slowly to an unanticipated growth in earnings, and the result is higher saving, at least in the short-run. Carroll and Weil (1994) provided strong evidence that growth causes saving (Granger Causality. Caroll and Weil (1994) used five year averages of the economic growth rate and savings for OECD countries and found that economic growth Granger caused savings
The view that growth appears to cause saving rather than the reverse has found support in several recent papers. Christopher et al. (1994) examined the relationship between saving and economic growth in a sample covering sixty four countries over several decades, and found that past growth predicts future saving rates, while past saving rates do not predict future growth.
The study of Gavin et al. (1997), where authors look at saving behavior in Latin America, also emphasizes that higher growth precedes higher saving rather than the reverse. It is only after a sustained period of high growth that saving rates increase and may do so with a delay that can be quite significant.
Alguacil et al. (2004) investigate the saving and growth relationship in Mexico from 1970-2000 using TYDL method. By taking into account both important variable foreign inflows (FDI) in complementing gross domestic saving (DS). Results of this paper show strong evidence of t casual relationship from domestic saving to economic growth. The paper also show foreign direct investment has a positive effects on domestic investment and Granger-causes the domestic economy in all case. support Solow��s growth model (1956) that show high savings lead high growth through capital accumulation and not vice versa.
In another study by Mohan, Ramesh, (2006), research was carried up to test the relationship between domestic savings and economic growth for various countries�� economies with different income levels. Using time series annual data, the Granger causality test was conducted. The study seeks to determine whether the direction of causality in these economies is different based on their income class: namely low?income, low?middle income, upper?middle income, and high?income countries. The result show in this study are LICs, a firm conclusion cannot be drawn in determining the direction of causality. In all of the LMCs, the causality is from economic growth rate to growth rate of savings. In all of the HICs, except Singapore, the causality is from economic growth rate to growth rate of savings. However, it appears that in UMCs bi-directional causality is more prevalent. The empirical evidence appears to favor the hypothesis that the economic growth rate causes growth rate of savings.
Oladipo (2010), using TYDL methodology to study the direction of casual relationship between saving and economic growth in Nigeria from 1970 until 2006. The empirical result show that the relationship between saving and economic growth are positively cointegrated, indicating a long-run stable equilibrium relationship. Further finding revealed that there is a unidirectional causality between saving and economic growth with the complementary role of FDI.
By using annual time series data from 1971-2007 in Pakistan, Shahbaz and Khan (2010) applied new approaches such as ARDL Bound Testing, Johanson cointegration and causality approaches to examine long run association while innovative Accounting Technique and Toda nad Yamamoto (1995) for causal relationship to re-investigate the relationship between economic growth and domestic saving in Pakistan. Result show that there is a long run relationship between economic growth and domestic saving. Causal result from innovative accounting technique show there is a one-way causality pointing from economic growth to domestic saving and a very weak from the other side. result from Toda and Yamamoto also confirm that economic growth leads to domestic saving in Pakistan.
Agrawal and Sahoo (2009) using the Granger Causality tests over the period of 1975-2004 in Bangladesh, the study found that, there is a bi-directional causality between savings and growth. Further finding by applying Forecast Error Variance Decomposition (FEVD) analysis using the VAR framework, the FEVD results confirm the causality results obtained using the Granger causality tests where saving rate affect the economic growth and economic growth affect the saving rate in Bangladesh.
3.1 STUDY DESIGN
The role of savings in helping country��s economic growth has been studied widely in terms of Harrod- Damor growth model. As the model presented by Harrod (1939) and Damor (1946), this model define that an economic growth rate over a time period, Yt is equal to the change in saving rate, St times with the capital output ratio, n (the return from investment).
Yt=St �� n (3.1)
Following the (3.1) model, the relationship between saving rate and economic growth is then been study by many scholar. One of the studies (Ciftcioglu, Karaaslan, Demir, 2000) using OLS method came out a regression model as such:
GR = �� + �� (SGNP) (3.2)
Where GR indicate real GDP growth rate, �� indicate the intercept, �� indicate the coefficient, and SGNP define as annual share of domestic saving in GNP. The study found that the impact of saving is positively related with economic growth. However, using simple classical OLS can only maximum test on the relationship between two variables. Knowing that the gap between total domestic saving to the country total investment can be supplement by foreign direct investment, FDI, thus the variable of FDI in this study should not be omitted. Therefore, this study attempt to extend the conventional growth model by splitting the saving date to two categories of real national saving, RNS and capital inflow from other foreign country specifically the foreign direct investment, FDI. So the following multiple regression model have been design as:
RGDPt = �� + ��1 (RGNSt) + ��2 (RFDIt) + ��_t (3.3)
Where the dependent variable RGDPt indicate real GDP growth rate over a time period, �� indicate the intercept, ��1 indicate the coefficient of RGDP growth rate, the independent variable RGNSt indicate real national saving rate over a time period, ��2 indicate coefficient of RFDI growth rate, the independent variable RFDIt indicate the FDI growth rate over a time series, and ��_t indicate disturbance. From the equation above, positive sign of coefficient ��1 for RGNSt means there is a positive relationship between real national saving with RGNSt variable. If there is an increase in RGNS, this will led to the economic growth in Malaysia. In contrast, if the coefficient is negative ��1 for RGNS, means there is a negative correlation to economic growth which proofs that saving will not led to RGDP growth.
3.2 SAMPLE SIZE
The study uses annual data from 1972 to 2009 to examine the long term relationship between the real growth rate of national saving, real growth rate of foreign direct investment, and the real growth rate of economic growth. The data such as net national savings, Foreign direct investment, net inflows, GDP, and consumer price index, CPI (2005 = 100) for the research are obtained from the World Bank (WB) and Bank Negara Malaysia monthly bulletin (BNM). The three variables, GDP, NS, and FDI are all subsequence being deflated by using the CPI to get the real growth rate. A total 38 samples has been collected in this study which starts from year 1972 to 2009.
3.3 STATISTICAL ANALYSIS
Multiple Regression method has been chosen in this paper to analysis the relationship between the independent variables national saving and FDI and the dependent variable GDP. The multiple regression model specifies dependent variable Yt as a linear function, affect by not jus one, but number of explanatory or independent variables.
Y_t=��_1+��_2 X_2t+��_3 X_3t+?+��_k X_kt+�� (3.4)
The above population multiple regression model show that there are one dependent variable, Yt , and K - 1 explanatory variables X2t , ��, Xkt , each having number of observation t = 1, ��,n. with ��1 as the constant or intercept and ��2 , ��, ��k as the coefficient.
The hypothesis is stated as below
H0: ��k = 0 (Do not have linear relationship)
H1: ��k �� 0 (Do have linear relationship)
The null hypothesis ��k = 0 against its alternative ��k �� 0, if less than lower bound critical value (0.05), then we do not reject the null hypothesis. Conversely, if the t-statistic value greater than 5 percent critical value, then we reject the null hypothesis and conclude that there are significant relationship between independent variable, X, and dependent variable, Y.
T-statistic is use for subsequent hypothesis test. Where the T-statistic can be compute as following equation:
T-statistic,t = (Estimator,�� ? �C hypothesized value,�� )/(Standard error of the estimator,S.E (�� ?))
Hence, if the computed value of the T-statistic is, within the center of t distribution based on n-3 degree of freedom (k=3, given 2 explanatory variables in this model), this prove that the null hypothesis is accepted where there is no linear regression relationship between the independent variable with the dependent variable. In contrast, if the computed value of the T-statistic is away from the t_a (n-2), a indicates the significant level, this mean the hypothesis null is being rejected and there is a significant relationship between the independent variable, X, with the dependent variable, Y.
Once the data have been run using SPSS software. The estimator coefficient will be generated. The R^2or the coefficient of determination is use to measure the goodness-of-fit of the multiple regression model in explaining the dependent variable, Y. In another words, R^2 coefficient of determination is a statistical measurement of how well the regression line approximate it real data points. As R^2 equal to 1.0 indicate that the regression line fits the data perfectly and vise verse if the R^2 equal to 0. Where SSR indicate sum of squares of the regression, SST indicate sum of squares (total), and SSE indicate the sum of square error. R^2 can be calculate as :
R^2= SSR/(SST )=1-SSE/SST , 0�� R^2 ��1.
4.0 RESULTS AND DISCUSSION
Table 1: Summary of Empirical Result
Coefficients, �� ? T-Statistic, t Adjusted R Square, (R^2 ) ?
Constant 0.025*** 2.170
Real GNS 0.426*** 9.361
Real FDI 0.015 1.285
*** indicate significant at 0.01 marginal level
The empirical result generated from SPSS software is summaries and report as table above. The regression model can be rewrite as below:
��RGDP��_t= 0.25 + 0.426 RGNS+ 0.015 RFDI + e_t R^2 = 0.710
note: t-statistic stated in ()
From the above equation, ��RGDP��_tdenotes the independent variable, the constant or intercept equal to 0.25. The first coefficient estimator for RGNS qual to 0.426 indicate that an increase of 1% in real GNS growth rate will increase 0.426% the growth rate of real GDP. The second coefficient estimator for RFDI equal to 0.15 indicate that an increase of 1% in real FDI growth rate will increase 0.015% of the growth rate of real GDP.
T-statistic is then been used to test out the individual coefficients to see their significant level in affecting the dependent variable. Whether the null hypothesis rejected or not can be tested using T-statistic. The null hypothesis is rejected if t>t_a (n-3). By using 5% level of significance, the critical value will be t_0.05 (38-3)= 1.6905. Using the formula (6) to compute the T- statistic for each coefficient of the independent variable, the result is show on table above 9.361 and 1.285 for both real growth rate of GNS and real growth rate of FDI. Therefore, by comparing the T-statistic of the coefficient of real growth rate of GNS, �� ?_2 with the critical value, which is 9.361 > 1.960. Hence, the result strongly rejects the null hypothesis and concludes that growth rate of real GNS is significant at 5 percent of significance level. In contrast, by comparing the T-statistic of the coefficient of the real growth rate of FDI, �� ?_3 with the critical value, which is 1.2850 < 1.960. Therefore the result does not rejects the null hypothesis and concludes that growth rate of real FDI is not significant at 5 percent of significance level.
The coefficient of determination, R^2 is use to test for the accuracy of the overall model. The result of R^2 equal to 0.710 means that in the sample data the variation in RGNS and RFDI able to explain approximately 71.0% of the variation in RGDP. This proof the equation as a whole of real GDP growth rate is well fit and explained by both independent variables of real GNS growth rate and real FDI growth rate.
As a conclusion, national saving rate plays a significant role in Malaysia��s economy growth. Through this research, the result shows that there is a positive relationship between GNS and economic growth, whereby the relationship between them is found to be significant. These finding may helps the government in formulating policy which concern the important of our National saving. In order for a country to achieve a higher living standard, saving must be emphasizing to accumulate a nation��s capital stock for higher productivity in the future. In addition, a higher GNS in a country can also increase the independency of a country without relying too much on foreign county borrowing or capital inflow.
Therefore, government should impose the relevant policies likes tax reduction to increase more saving. The government should have well control of a government spending since the government expenditure and subsidies exhibition a large part of the country spending. Given that household saving is one of the biggest part in the total saving, the government and commercial banks should promote more on saving by giving higher interest rate for saving.
Besides, government should impose policy that attract more FDI into our country to increase employment rate and technology transfer in Malaysia. Knowing that by inviting more foreign direct investment will have negative effect to the domestic producers as the competition will be increase. Thus, policy such as joint venture should be encourage, so that the domestic producer can work together with foreign investor and expose themselves with higher technology besides enjoying profit together.
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