Case Study 4.2e "How Savings Rates Affect Domestic Economies"

Directions: Complete the following case study and record your answers on a separate sheet of paper.

Topic: The factors that cause different savings rates in various nations, and the effect that a savings rate has on a domestic economy.

Objective: To examine how savings rates around the world vary due to a nation's income, level of positive growth, fiscal policies, pension policies, level of debt, demographics and public uncertainty, and to explore how high or low levels of savings affect national economies.

The savings rate, or ratio, is a calculation of the amount of income saved after consumption. Suppose a private household has an annual income of $2,000 a month. If the monthly household expenses are only $1,500, then a total of $500 can be saved. This equals a savings rate of 25 percent. By examining a nation's gross domestic product (income), its gross domestic savings and its amount of consumption (household expenses), economists can create a savings rate expressing the average savings on a national scale. Savings rates and long-term economic growth are inherently related. High savings rates lead to greater economic prosperity. In turn, prosperity leads to higher rates of saving. Nations with low savings rates often become trapped in a cycle of poverty. Their low rates of savings lead to low rates of economic growth. When the rate of a nation's growth falls, then the savings rates continue to fall as well.

Savings rates vary greatly between nations and even between regions. In some East Asian nations, savings rates have almost doubled. The rates average 30 percent of these nations' disposable income. In Latin America, savings rates have dropped to 15 percent. In Sub-Saharan Africa, the rates are down to 10 percent. Industrialized nations are also seeing a decline in savings. In the United States, the savings rate has been declining since the 1960s. It currently averages only 4.8 percent. Over the years, many economists have debated the factors that cause different rates of saving. A recent report by the World Bank identifies links between seven factors: income, growth, fiscal policy, pension reform, external borrowing (foreign aid), demographics and public uncertainty.

CS Question 1: What are the seven basic factors that influence savings rates?

In many cases, additional income drives savings rates up. The more money a household makes, the easier it is for that household to meet expenses. Once expenses are met, it becomes easier to save money. The effect of income on savings is different in developing nations than it is in industrialized nations. Industrial economies have a lower savings rate. This suggests that the influence of additional income on savings lessens at medium or high levels of income.

Economic growth is another factor in a nation's savings ratio. In times of economic growth, incomes rise, which in turn pushes up the savings ratio. While a high rate of savings can spur growth, the growth is temporary and eventually disappears. This suggests that growth leads to greater savings, but greater savings lead to only short-term growth.

CS Question 2: What is the relationship of income and growth on savings rates?

National governments also have a large effect on savings rates. Governments can influence savings through fiscal policies, pension reforms and the amount of external borrowing. Increasing public saving through government trusts can increase the national savings rates. Some economists recommend providing a tax break on certain forms of saved income to encourage more individuals to save money. However, this has not proven to be effective. Pensions also play a role by placing the responsibility to save on the government rather than on the individual. Economies with pay-as-you-go pension plans show a lower rate of individual savings. The amount a government borrows from other nations also affects the national savings rate. Borrowing tends to replace savings. This drives savings rates down, especially in economically troubled nations. In developing nations, however, borrowing can sometimes spur growth, leading to a rise in savings rates.

CS Question 3: How can a government affect its nation's savings rates?

Demographics and public uncertainty also play roles in a nation's rate of savings. An increase of young dependents in a population can decrease the savings rates, while nations with a large working population may experience an increase in savings rates. Yet as demographics shift toward an older population, savings rates fall. When workers retire, they often use their savings to continue paying household expenses. If enough of the population retires over a short period, savings rates can fall dramatically. An increase in public uncertainty can also lead to higher savings rates. Households fearing economic instability will try to set aside resources for the future, hoping to "weather the storm."

CS Question 4: How do a nation's demographics and public perception influence its savings rates?

Further Thought: