Impact of Saving Rate on Economic Growth
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Published: Thu, 16 Aug 2018
- NURU ABUBAKAR
Saving rate is the amount of money, expressed as a percentage or ratio which one deducts from his/her disposable personal income to set aside for retirement or for investment in the money or the capital market in instruments like bonds treasury bills, shares etc. Savings rate can also refers to the percentage of gross domestic product (GDP) that is saved by households in a country (Ewa and Agu 2005). This indicates the financial state and growth of the country because households’ savings constitute the major source of government borrowing to finance public projects and also provides funds for private investments. It is an obvious fact that income is received as wages or salaries, rents, interests or profits by owners of factors of production. With the received income households buy the consumer goods they need. Not all personal income available to the individual or family, or the household is for personal use. The government takes a sizable amount in the form of personal income taxes. After these taxes are paid, what is left with the individual is disposable income (Ogunbitan 2010). Disposable income is used to pay for consumer goods and services, to pay interest on debts and for savings. Disposable income is an important concept because the income enables the consumer to decide how much to spend on current goods and services and how much to save.
Savings is therefore that part of disposable income that is not spend on current consumption of goods and services but reserved for future use. Economic growth on the other hand is the process by which there is a sustained rise in real per capita income or output of goods and services over a given period of time (Ewa and Agu 2005). A positive relationship exists between savings rate and economic growth because when savings rate is high banks have more capital to lend for capital investments to both private investors and the government (Tawiah 2006). When savings rate is increased, economic growth certainly will increase because more capital is available to investors at reduced interest rates leading to increases investment in the capital stock. This study therefore focuses on exploring how savings rate impact economic growth
THE IMPACT OF SAVING RATE ON ECONOMIC GROWTH
Savings implies refraining from consumption. A consumer’s disposable income is either consumed or saved. The rate at which different consumers consume and save part of their disposable income apparently differs (Bleaney, Gemmell and Kneller 2001). This implies that different consumers have distinct average propensity to consume (APC) and average propensity to save (APS). These averages explain how much a consumer consumes and saves at a particular level of income. Similarly, there is marginal propensity to consume (MPC) and marginal propensity to save (MPS). The marginal propensity to save represents the fractional part of an increase in income that is saved. Aggregate saving assembles idle funds from surplus units to deficit units in the economy facilitating investment both by the private and public sector (Ogunbitan 2010). When aggregate savings improves, financial institutions are in position of funds to borrow their customers and government alike. The rate of interest actually determines investment in a country. The lower the interest rate charged by banks, the better investors are attracted to borrow for investment (Buscemi and Yallwe 2012).
Income earned is either consumed or saved, that is, Y = C + S where Y represents income, C, consumption and S, savings. From the above linear function, saving means income less consumption, that is, S = Y – C. Savings therefore is affected by active spending decisions. There are basically three types of savings, namely; personal saving, business saving and government saving
Personal savings is influenced by the following factors;
- Size of income: as income increases all things being equal, savings also increase
- Rate of interest: a higher rate of interest may attract more people to save and vice versa
- Government policy: the government can influence the level of savings in different ways such as attractive rate of interest policy and income tax relief or tax holidays or tax concessions (Ogunbitan 2010).
- Sense of responsibility: people with careful spending habits save even when the income is low compared to extravagant people who don’t even save at higher income levels.
- Political situation: a country with a stable political climate encourages citizens as well as foreign investors to save and invest which results into economic growth.
The second form is business saving and is affected by the following:
- Profits: to encourage and affect savings, profit is necessary. The higher the profit the greater the inclination to save. Also, when profit is attractive directors of companies keep aside part of the profit to plough back into the business for growth and expansion (Bleaney, Gemmell and Kneller 2001).
- Anticipated rise in prices: when business units anticipates rise in price level, they increase their quantum of savings through investment goods to reap later the anticipated rise in price (Tawiah 2006)
- Government policy: an increase tax on company’s profit will reduce tax and vice versa
The third form of savings is government saving. Government saving is achieved chiefly through a budget surplus. This may be secured by increasing revenue through additional taxation or by reducing current government expenditure. Apart from a budget surplus, saving can occur in other forms, such as when national insurance and pension contributions exceed current payments (Tawiah 2006).
Reasons for saving; individuals may choose to save for some of the following reasons
- To provide for old age or for future expenditure
- To guard against a rainy day or unforeseen circumstances
- To leave an estate for immediate children or grand children
- Sometimes people save to become wealthy and raise their status in the society.
Relationship between savings and investment
In a frugal or savings economy, part of the earned income is consumed and part is saved. Let’s assume the following;
- That household spend only part of their income and save the rest
- There are some firms which produce consumer goods and some which produce investment (that is, producer or capital goods), and
- That all savings is undertaken by firms
It is also important to explain withdrawals and injection. Savings and investment are examples of two other general categories of expenditure called withdrawals and injections respectively.
An injection is an addition to the income of a domestic firm that does not arise from the spending of households or an addition to the income of domestic households that does not arise from the spending of the firms (Ewa and Agu 2005). A withdrawal on the other hand is any income that is not passed on in the circular flow of income and expenditure.
Having established that part of aggregate personal incomes (that is, the national income) will be spent on consumer goods and part will be saved, it then follows that: National Income = Amount spend on consumer goods + Amount saved, that is, symbolically,
Y = C + S ……………………………………………………………………..1
S = Y – C……………………………………………………………………….2
Where Y = Income
C = Consumption and
S = Savings
Considering national income as the value of the volume of the goods and services produced in which we have two parts, namely: consumers’ goods (C) and producers goods (investment), the following equation could be deduced
National income = amount of consumer goods produced + amount of producer goods produced
Since the production of investment good is an investment, the following equation could be obtained
Y = C + I …………………………………………………………………………….1
I = Y – C …………………………………………………………………………….2
We can now deduce that since equation 2 above is stated that Y – C = S and where Y = income, C = Consumption and S = saving
Equation 4 states that Y – C = I. similarly Y = Income, C = consumption and I = Investment equations 2 and 4 gives the equality of saving and investment.
Y – C = S established from 2 above and
Y – C = I recall, 4 above, then it implies that
S = I……………………………………………………………………………….1
Since Y = C + S recall equation 1 above and
Y = C + I recall equation 3 above, that is
C + S = C + I……………………………………………………………………..2
Hence, S = I
From the above analysis, it can be concluded that the equilibrium level of national income is determined when savings equals investment. It follows therefore that changes in either savings or investment will bring about changes in the national income. For instance, when savings exceeds investment income will fall but when investment exceeds savings, income will rise. This is because more saving but less investment will mean less employment of factors leading to lower total output and hence lower national income. On the contrary, more investment but less savings, will mean employment of more factors leading to greater total output and, hence, a higher national income. There is stability, that is, balance or equilibrium in the level of national income only when saving is equal to investment.
Economic growth implies more output per head as a result of more input and more efficiency. The output per head determines the standard of living in a country. Countries worldwide get preoccupied with horrendous efforts directed towards raising the rate of economic growth. This is the desire of the peoples in different countries to raise the level of their well-being. Economic growth is influenced by different factors which include; the skills and efforts of the labor force, the rate of investment, and the type of investment which is induced by appropriate level of savings, technological progress, availability and extent of the exploitation of natural resources, the persisting climate in the trade relationship with other countries, the extent of specialization, social and religious organization as in the qualities of the people’s character, government policy etc.
It is established from the above analysis the equality of aggregate savings to aggregate investment, and can be deduced that when savings rate is high in the economy, banks have more capital to lend for capital investment, which in turn promotes the volume of goods and services produced in the economy. That is, when savings rate increases, economic growth would certainly increase because more capital is available at reduced interest rate. This will also lead to increased investment in capital stock. It then implies that savings is a veritable tool that promotes investment in any given country. When investment is improved, there is increase in the volume of goods and services produced, stimulated by the savings rate which in turn leads to higher gross national income figures. This figures when measured leads to higher income per head and increased real income of the citizens.
When government policies favor both households and firms who are the major agent of production, it leads to higher rate of savings and higher rate of savings provides funds available to prospective investors who borrow from either the financial institutions or from the money market on short term basis and from the capital market on long term basis. The improvement in the level of economic activities continues with additional savings as a result of improvement in the various sectors of the economy and eventually economic development is attained which is the goal and pursuit of all economies. It is therefore not out of place to conclude that savings rate in an economy can boost economic growth. Government should always ensure that monetary policies like attractive rate of interest on savings, bank rate, liquidity ratio etc. and fiscal policies like tax rebate, tax concessions and tax holidays are favorable at all times for the firms and household who are the major agent of production process in the economy to continue to accumulate loanable funds by banks to accelerate investments. The rate of savings in an economy is a determinant of economic growth.
Bleaney, M, N Gemmell, and R. Kneller. “Testing the endogenous growth model: public expenditure, taxation and growth over the long-run.” Canadian Journal of Economics, 2001: 36-57.
Buscemi, Antonino, and Alem Hagos Yallwe. “Fiscal Deficit, National Saving and Sustainability of Economic Growth in Emerging Economies: A Dynamic GMM Panel Data Approach.” International Journal of Economics and Financial Issues, 2012: 126-140.
Ewa, U, and G. A. Agu. “New System Economics for A’level.” Africana First Publishers Limited, 2005: 180-181.
Ogunbitan, O. Easy to Understand Economics. Rasmed Publication Limited, 2010.
Tawiah, P. Basic Economics for West Africa. Idodo Umeh Publishers Ltd., 2006.
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