The economist begins its series on explaining the pattern of global saving
and investment which is intended to shed light on the low long-term interest
rate puzzle with a useful summary of theories of why people save and why people
What causes people to save and invest?, The Economist: At first sight, the idea of a “saving glut”—an excess of saving over investment—seems odd. According to the economics textbooks, saving and investment are always equal. ... And indeed that is true for the world as a whole, but it is not true for individual countries. ... the amount an individual country saves does not have to be the same as the amount it invests. The difference between the two is the amount borrowed from or lent to foreigners; this is called the current-account deficit or surplus... Moreover, whereas it is true that at a global level saving must equal investment, the fact that saving and investment end up in balance does not mean that ... households and individuals ... desire to save and invest in equal measure. ... Actual saving and investment must be equal. Desired saving and investment may not be.
Most of the time, ... If people's desire to save exceeds their desire to invest, interest rates will fall so that the incentive to save goes down and the willingness to invest goes up. Across borders, exchange rates have a similar effect. ... But there is some uncertainty about how smoothly these adjustments are made. Classical economic theory suggests that interest rates automatically bring saving and investment into a productive balance. The central principle of Keynesianism, however, is that this alignment between saving and investment is not always automatic, and that a misalignment can have serious consequences. ... The modern consensus is that both classical and Keynesian theory can be right, but over different time frames. In the long term, saving and investment will be brought into line by the cost of capital. But in the short term, firms' appetite to invest is volatile, and policymakers may need to step in to shore up demand. Thus, although saving and investment are equal ex-post, economic theory leaves plenty of room for an ex-ante saving glut...
What might change people's desire to save or invest? ... The most influential theory of household saving is the “life-cycle hypothesis” ... It suggests that people try to smooth consumption over their lifetime: they save little or nothing when young but more in their middle years if they have a good income. They then draw down those savings in retirement. ...demographic shifts and economic growth are the most important drivers of thrift. Another theory suggests that people save for “precautionary reasons” ... This implies that people will save more if their income is variable. It also suggests that they will be more inclined to save if they have no access to credit. A third possibility is that people save because they want to leave assets to their children, either because they love them or as a way to bribe the children to look after their parents in old age. ... the bequest theory of thrift suggests that savings might not actually be drawn down in retirement. A final possibility is that people save in response to their government's actions. This theory, known as “Ricardian equivalence”, suggests that people save more if government saves less because they expect higher taxes later on. How well do these theories fit with what has actually happened in the past? ... in general, the following factors seem to play a role:
•Demographics. ...Saving rates do rise when the ratio of children in the population falls (as in China), and decline when the proportion of pensioners rises (as in Japan). Given that the world's population as a whole is ageing ... global saving should currently be rising.
•Economic growth. Especially in poorer countries, saving rates rise as economies grow. That is probably because people do not adjust their consumption patterns as quickly as their income rises...
•Terms-of-trade shock. If a country's exports suddenly go up in price, its saving rate tends to go up too, at least temporarily. Oil exporters, for example, put on a saving spurt if oil prices rise. This effect also helps to explain the recent increase in saving in many emerging economies.
•Financial development. As an economy's financial system becomes more developed, saving rates tend to fall because people find it easier to borrow. ... It suggests that saving rates may be lower in countries with more sophisticated financial systems, such as America.
•Capital gains. In rich countries ... If the stock market or house prices rise, people feel richer and save less. A study by the OECD published late last year suggests that housing wealth has a bigger effect on saving than financial wealth...
•Fiscal policy. In some countries, people do appear to behave as Ricardian equivalence theory suggests: they save more when budget deficits expand, perhaps because they expect higher taxes in the future, although private-sector saving rises by less than the rise in budget deficits. The big exception is America, where the impact of fiscal deficits on private saving appears to be weakest.
Some of these factors work in opposite directions ... But there are indications that in rich countries the biggest disincentives to saving have been capital gains and the ability to borrow. ... In emerging markets, on the other hand, the most powerful factors pushed in the opposite direction. Fast economic growth and increases in government saving, thanks partly to terms-of-trade shocks, have increased total national saving. ... If there is a glut of saving, it is likely to be found in emerging economies and oil-exporting countries.
...In theory, firms should invest if the expected return on their investment exceeds the cost of the capital they are using. In the short term, firms need to worry about the state of overall demand. But in the long term, returns on capital depend on how much capital an economy already has, how productively it is used, and how fast the workforce is growing. If there is little capital available or the workforce is growing rapidly, firms would usually expect a high return on investment. The evidence supports these theories, up to a point. ... However, in recent years these statistical relationships have failed to hold. Both in rich countries and in emerging economies (except China), investment levels have been lower than economists had expected at the levels of interest and growth rates prevailing at the time. Much of Mr Bernanke's saving glut is due to this unexpectedly low rate of investment. ... several “structural” explanations have gained support:
•Demographics. A young and growing workforce boosts the level of investment, just like a mature workforce boosts the saving rate. ... But although demographics are important, they change slowly. It is hard to ascribe the recent sharp drop in investment demand in regions such as Japan or East Asia to demographic change alone.
•Declining capital intensity. Firms in rich countries may not need to invest as much as they used to because the share of capital-intensive industries in their economies is shrinking. ... But [this] does not explain investment busts in poor countries.
•Deflation of capital-goods prices. In recent years prices of capital goods have fallen sharply relative to prices of other goods and services, thanks largely to cheaper computers, so companies are able to achieve the desired level of real investment for a smaller outlay. ... This may help to explain some of the recent weakness in investment, particularly in rich countries. But it is unlikely to last. ... More important, computers depreciate more quickly than other capital goods, so eventually firms will need to invest more to maintain the same level of net investment.
•The rise of China. This may have prompted a geographic shift in global investment patterns. ... But investment flows to China from America, Europe and Japan are not yet big enough to explain the sluggish investment in those countries...
In sum, none of these explanations for a structural, global decline in investment is altogether convincing. To understand the pattern of global saving and investment properly, you have to look in detail at what is going on within the world's main saving and borrowing countries. The best place to start is the biggest net saver of all, Japan.
More to follow...