SG: Chapter 15
FBAH: Chapter 9
TOPIC 5: ECONOMIC GROWTH: SAVING,
INVESTMENT, POVERTY AND INFLATION
DR. XU LE
NUS BUSINESS SCHOOL
WHAT DETERMINES ECONOMIC GROWTH &
HOW TO FINANCE ECONOMIC EXPANSION?
(ROLE OF SAVING & INVESTMENT)
SAVINGS AND WEALTH
• Saving is current income minus spending on current needs
§ The saving rate is saving divided by income
• Wealth is the value of assets minus liabilities
§ Assets are anything of value that one owns
§ Liabilities are the debts one owes
§ The balance sheet is a list of an economic unit’s assets and liabilities
•
Every dollar a person saves adds to his wealth
n
A high rate of saving today leads to an improved standard of living in the future.
THREE REASONS FOR HOUSEHOLD SAVING
1.
Life-cycle saving is to meet long-term objectives
§ Retirement
§ Purchase a home
§ Children’s college attendance
2.
Precautionary saving is for protection against setbacks
§ Loss of job
§ Medical emergency
3.
Bequest saving is to leave an inheritance
§ Mainly higher income groups
EXPLAINING U.S. HOUSEHOLD SAVINGS RATE
FACTORS AFFECTING SAVING RATE
Savings rate may be depressed by
§
§
§
§
§
§
Social Security, Medicare, and other government programs for the elderly
Mortgages with small or no down payment
Confidence in a prosperous future
Increasing value of stocks and growing home values
Readily available home equity loans
Demonstration effects and status goods
NATIONAL SAVINGS
•
Macroeconomics studies total savings in the economy
§ Household savings is one component
§ Business and government savings are other parts
•
Assume NX = 0 for simplicity
•
National savings (S) is current income less spending on current needs
§ Current income is GDP or Y
•
Spending on current needs
§ Exclude all investment spending (I)
§ Most consumption and government spending is for current needs
§ For simplicity, we assume all of C and all of G are for current needs
S=Y−C−G
PRIVATE SAVING
1
•
Private saving is household plus business saving
•
Household's total income is Y
•
Households pay taxes from this income
§ Government transfer payments increase household income
§ Transfer payments are made by the government to households without receiving
any goods in return
§ Interest is paid to government bond holders
T’ = Taxes − Transfers − Government interest payments
Sprivate = Y – T’ - C
PUBLIC SAVING AND NATIONAL SAVING
•
Public saving is the amount of the public sector's income
that is not spent on current needs
§ Public sector income is net taxes
§ Public sector spending on current needs is G
SPUBLIC = T’ − G
•
National saving (S) is private savings plus public savings
SPRIVATE + SPUBLIC = (Y − T’ − C) + (T’ − G)
S=Y−C−G
NATIONAL SAVINGS, 1960 - 2016
Since 1960, national savings rate has been 9 – 19%
THE GOVERNMENT BUDGET
•
Balanced budget occurs when government spending equals net
tax receipts
§ Government budget surplus is the excess of government net tax collections over
spending (T − G)
§ Budget surplus is public savings
§ Government budget deficit is the excess of government spending over net tax
collections
§ Budget deficit is public dissavings
GOVERNMENT SAVING
Federal Government (billions of dollars)
Receipts
Expenditures
2000
$2,063.2
1,906.6
State and Local Governments
Receipts
1,303.1
Expenditures
1,293.2
Federal Government (billions of dollars)
2016
Receipts
Expenditures
$3,452.1
4,149.4
State and Local Governments
Receipts
2,416.3
Expenditures
2,583.7
National Saving, 1960 - 2016
© 2019 McGraw-Hill Education.
Access the text alternative for these images
13
LOW HOUSEHOLD SAVINGS
•
National savings determines a country’s ability to invest in new
capital goods
§ Household savings has been low
§ Business saving has been significant
§ In the 1990s, government saving increased
•
•
•
From 1960 to 2002, national saving rate was fairly stable
From 2002 to 2007, government dissaving contributed to a decline
in the U.S. national saving rate
Much larger government dissaving during 2007-2009 recession
SAVING, INVESTMENT, AND GROWTH
Financing & Powering Growth
•
Saving àInvestment àincreasing the output (GDP)
•
Growth will materialize if there is concurrent growth in manpower and supporting
resources & institutions
•
Suppose in an open economy, NX is non-zero. Sources of savings to finance growth:
Y = C + I + G + ( X − IM )
I = Y − C − G − ( X − IM )
I = (Y − C − T ') + (T '− G) + (IM − X )
Investment=Private Saving + Government Saving +Foreign Saving
Business Saving + Household Saving
SAVING, INVESTMENT, AND FINANCIAL
MARKETS
What helps to equilibrate Savings & Investments?
•
Supply of savings(S) is the amount of savings that would occur at each possible
real interest rate (r)
§ The quantity supplied increases as r increases
•
Demand for investment (I) is the amount of savings borrowed at each possible
real interest rate
§ The quantity demanded is inversely related to r
FINANCIAL MARKET (LOANABLE FUND MARKET)
TECHNOLOGICAL IMPROVEMENT
•
New technology raises marginal
productivity of physical capital
§ Increases the demand for
investment funds
§ Higher interest rate
§ Higher level of savings and
investment
GOVERNMENT BUDGET DEFICIT INCREASES
• Government budget deficit
increases
n Reduces national saving
n Higher interest rate
n Lower level of savings and
investment
• Private investment is crowded
out.
ECONOMIC GROWTH AND SAVING RATE
Harrod-Domar Growth Model
Consider the case when
•
Output-capital ratio, A=Y/K, which average capital productivity is constant;
•
The saving rate, s=S/Y, and
•
Depreciation rate (d) of capital is constant.
•
Harrod-Domar Growth model provides an equation for the growth rate of GDP;
•
Then,
G(Y)=sA-d
Example: s=15%; Output-capital ratio (A) =1/3; Depreciation rate = 2%, then growth
in GDP = 15%*1/3-2%=3%
•
The Harrod-Domar economic growth model stresses the importance of savings
and investment as key determinants of growth
SAVING RATE & STANDARD OF LIVING
•
Policymakers know the benefits of increased national saving rates
§ Reducing government budget deficit would increase national saving: reducing G,
increasing T
§ Political problems : especially when G relates to social spending
§ Increase incentives for households
§ Increasing Consumption tax
§ Reduce taxes on dividends and investment income
•
Higher national saving rate leads to greater investment in new capital goods and
a higher standard of living.
•
In Harrod Domar growth model, higher saving rate can result in higher economic
growth rate. Average productivity of capital is constant.
•
Higher saving rate may not bring about high rate of economic growth when there is
diminishing return to the increasing using of capital.
ECONOMIC GROWTH IN DEVELOPING
COUNTRIES
Rostow: Stages of Economic Growth
Five key stages that countries seem to go through to attain development
1)The traditional society :
§ employment in subsistence agriculture and low living standards prevent saving &
investment
2)Establishing preconditions
§ Agricultural productivity increases and emergence of entrepreneurial merchants
3)The take-off
§ Increasing investment and growth, generate momentum to lift the whole economy
4)The drive to maturity
§ Success extend to other sectors; pace of investment & growth becomes self-sustaining
5)The age of high mass consumption
§ Living standards are increased for all.
Stage 1 consists of a vicious circle where low incomes prevent savings; no savings means no
domestic investment; and no investment means no growth of incomes. However, there is
also a formula for success: establishing the preconditions in Stage 2 leads on to Stage 3, to
stage 4 and thus 5.
POLICIES FOR ECONOMIC GROWTH
Government Policies to Promote Economic Growth
•
Governments support education and training programs
§ Government pays because education has externalities
•
Government policies can encourage new capital formation and saving in the
private sector–fiscal incentives
§ Government can invest directly in capital formation (infrastructure: logistics and
ICT)
•
Research and development (R&D) promotes innovation
•
Government legislation to protect intellectual properties and copyrights
•
Building the National Innovation System.
DEVELOPMENT ISSUES IN DEVELOPING
COUNTRIES
Q: Why a country is poor and under developed?
A: Recall the 6 Determinants of labour productivity. They could be weak or lacking in
that country. In addition, the country could be stuck in a “poverty trap” –also
called the vicious cycle of poverty.
§ The vicious circle of poverty is a result of the various vicious circles which were on
the sides of supply and demand for capital. As a result capital formation remains
low productivity and low real incomes. Thus, the country is caught in vicious circles
of poverty which are mutually aggravating and it is very difficult to break them.
VICIOUS CIRCLE OF POVERTY
§ Poverty is generally measured with reference to a poverty line - the minimum level
of income or consumption deemed adequate in a particular country. ... In October
2015, the World Bank updated the international poverty line to US$1.90 a day.
POLICIES FOR ECONOMIC GROWTH
•
Prescription for more human and physical capital is broadly correct
§ Appropriate technology and education
•
Most countries need institutions to support growth
§ Corruption creates uncertainty about property rights and drains financial
resources out of the country –capital flight
§ Clear rules and incentives that promotes entrepreneurship
§ Competitive market and absence of state monopolies
§ Political stability encourages foreign investment
GROWTH RATES AND CHANGES IN POVERTY
RATES, SELECT COUNTRIES
RECOGNIZING LIMITS TO GROWTH
•
There are identifiable and imminent limits to growth founded on:
§ The depletion of resources
§ Pollution of the ecosystem
•
Some thinks the above being too pessimistic and suggest that solutions come in
the form of:
§ Technological advancement
§ Market adaptation
GROWTH & INFLATION
•
Inflation: An increase in the general (average) level of prices of goods and
services.
•
Inflation often accompanies growth, especially when either resources available for
expansion is restricted, or aggregate demand out run the aggregate supply.
•
Inflation –a mechanism for redistributing income and wealth –it acts like a tax,
taking income or wealth from one group and giving it to another.
•
Redistributive effects of inflation: it makes some people worse off, it also makes
other people better off. Consider debtors vs creditors in an inflationary situation.
•
It has the following effects: (a) Price effect; (b) Income effect; (c) Wealth effect
COST & CAUSES OF INFLATION
•
Cost of inflation: uncertainty in business planning and decision making. Inflation
may lead to excessive speculation, lessening effort in production, encouraging
distorted behavior of hoarding or withholding the supply to gain higher pecuniary
returns. Situation may develop into hyperinflation and economic crisis.
•
Causes of inflation:
•
For the monetarists, inflation is always a monetary phenomenon, with money
supply expanding faster than real output growth.
•
Based on ADAS framework, we can highlight 3 causes:
§ Demand Pull inflation;
§ Cost-Push inflation;
§ Imported Inflation
CAUSES OF INFLATION
SUMMARY