Very often, some ideas are counterintuitive, and in economics even more so. Many of us grew up hearing that saving money is a good thing to do. We were told, at least in my case, that a family that saves is a virtuous example to follow. Thinking about the future and preparing for it denotes a sense of responsibility and, therefore, promoting a financially secure life through savings should be a value to instill in one’s children.
However, when it comes to savings in aggregate terms, there is a clear paradox that often comes as a huge surprise when you talk about it in certain circles. The counterintuitive thing about saving is that, while the above may be good advice to pass on to a daughter or son, it is not necessarily good advice for an economy as a whole. Although it may seem strange to understand, an economy that saves too much is an economy with an unsustainable growth model. If you like, we can call it not very “virtuous.” Saving should therefore be neither too much nor too little, but just the right amount.
Let’s look at the paradigmatic case of China. Paul Krugman wrote a few days ago about the problems facing the Asian economy. Its model, with an investment that multiplies that of Western countries, forces society — let’s remember that state planning is high — to save excessively. And no, every supply does not create its own demand, even more so if it saves a lot. The result is savings that are channeled into investment projects of dubious profitability that threaten to collapse an unsustainable model. Just look at the country’s real estate crisis.
Does this mean that society has to save little? No, it does not. A society that saves little compromises its own future development and its own well-being. Therefore, strange as it may seem, saving plays a dual role in the economy, and this role of villain and hero must be played in the most balanced way possible. Hence the confusion among economists about its role and relevance.
Let’s play with reductio ad absurdum. If we think of an economy that does not save, we are facing a situation that makes investment unviable. Thus, without savings there is no investment, and without investment there is no long-term growth. There is little to discuss here. However, we might think that the more savings, the more investment and the more growth. And this is not necessarily so. Capital, like any other productive factor, has diminishing marginal returns: the next unit of productive capital created is likely to generate less profitability, all else being equal.
Moreover, profitable investment projects exist not only because of savings (supply does not always generate its demand), but particularly because of factors such as population growth or technological change. An investment decision is not accepted or rejected only because of the cheapest or most expensive availability of savings, but also because of the profitability of the investment, whether there will be a market to sell it, whether this market is dynamic, and whether the production cost structure means that the investment is based on efficient production processes. There are many variables that decide whether a project is profitable or not and, therefore, whether it is worth investing.
Thus, a lot of savings without a matching demand for investment can generate a collapse in the profitability of the former, which partly supports the secular stagnation thesis to explain these past years of low rates. After all, in the capital market there is a supply (those who have savings) and a demand (those who want those savings). To say that supply is all that matters ignores demand, which is just as relevant as supply.
But there is more, since the demand for investment depends, curiously, on the supply of savings. In the short term, too many savings means too little consumption. If we invest in new projects, but then have no one to sell the products to, the savings go unrewarded and the system collapses. We then look for external demand (look again at China) or invest in alternative assets, such as financial assets, which can generate bubbles. An excess of savings is therefore not convenient, as it discourages consumption, the ultimate driver of an investment.
Obviously, an economy can play with its external balance to finance projects even when it has no domestic savings. In other words, it can exceptionally invest without the availability of savings, since it can resort to international capital markets. In this case, even if receiving this injection is conditional on an efficient disposal of debt in profitable projects, we could talk about the fact that even an economy with scarce savings could grow.
For all these reasons, we can argue that saving too much (the borderline should be defined) is not beneficial. But saving too little is not positive either. The ability to finance investment projects by drawing on one’s own capacity to finance them ensures long-term growth if financial markets properly allocate resources to specific projects.
The capacity of an economy to save is tied to its income, although other factors play a role in this regard, such as demographics, the tradition of an investment-oriented, productive or entrepreneurial productive fabric, or other reasons that may go beyond the limits of the economy itself. In other words, nothing is simple, and even less so when it comes to economics and savings.
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