Sunday, November 23, 2014

The Saver’s Dilemma

BEIJING – Most of the international financial crises that have occurred over the last 200 years were the result of strains created by the recycling of capital from countries with high savings to those with low savings. The current European crisis is a case in point. For nearly a decade, capital from high-savings countries like Germany flowed to low-savings countries like Spain. The resulting build-up in debt created its own constraints, and now Europe’s economy is forced to rebalance.

If the rebalancing takes place only in Spain and other low-savings countries, the result, as John Maynard Keynes warned 80 years ago, must be much higher unemployment. Whether unemployment remains confined to countries like Spain, or eventually migrates to those like Germany, depends on whether the former remain in the euro.

Although the relative savings positions of Germany and Spain seem to confirm cultural stereotypes, national savings rates have little to do with cultural proclivities. Instead, they largely reflect policies at home and abroad that determine household consumption rates.

A country’s overall consumption rate is, of course, the flip side of its savings rate. Apart from demographics, which change slowly, three factors largely explain differences in national consumption rates.

First and foremost is the share of national income that households retain. In countries like the United States, where households keep a large share of what they produce, consumption rates tend to be high relative to GDP. In countries like China and Germany, however, where businesses and the government retain a disproportionate share, household consumption rates may be correspondingly low.

The second factor is income inequality. As people become richer, their consumption grows more slowly than their wealth. As inequality rises, consumption rates generally drop and savings rates generally rise.

Finally, there is households’ willingness to borrow to increase consumption, which is usually driven by perceptions about trends in household wealth. In Spain, for example, as the value of stocks, bonds, and real estate soared prior to 2008, Spaniards took advantage of their growing wealth to borrow to increase consumption.

But this is not the whole story. Consumption rates can also be driven by foreign policies that affect these three factors. For example, an agreement in the late 1990’s among the German government, corporations, and labor unions, which was aimed at generating domestic employment by restraining the wage share of GDP, automatically forced up the country’s savings rate. Germany’s large trade deficits in the decade before 2000 subsequently swung to large surpluses, which were balanced by corresponding deficits in countries like Spain.

As Spain’s tradable-goods sector contracted in response to the expansion in Germany, it could respond in one of only three ways. First, Spain could refuse to accept the trade deficits, either by implementing protectionist measures or by devaluing its currency. Second, it could absorb excess German savings by letting unemployment rise as local manufacturers fired workers (because rising unemployment forces down the savings rate). Finally, Spaniards could borrow excess German savings and increase consumption and investment.

Of course, Spain could not legally choose the first option, owing to its EU and eurozone membership, and, not surprisingly, was reluctant to choose the second. This left only the third option. Spaniards borrowed heavily prior to the crisis to increase both consumption and investment, with much of the latter channeled into wasteful real-estate and infrastructure projects.

This continued until 2007-2008, when Spanish debt levels became excessive. But, as long as Germany does not absorb its excess savings and accommodate the desired rise in Spanish savings, Spain is still faced with the same options. Once borrowing is no longer possible, Spain must either intervene in trade – which implies leaving the eurozone – or accept many more years of high unemployment until wages are driven down sufficiently to produce the equivalent of currency devaluation.

This is the key point. Low-savings countries cannot easily adjust without an equivalent adjustment in high-savings countries, because their low savings rates may have been caused by high savings abroad. After all, savings and investment must be in balance globally, and if policy distortions cause savings in one country to rise faster than investment, the reverse must occur elsewhere in the world.

In other words, savings rates in Spain and other deficit countries in Europe had to drop once policy distortions forced up Germany’s savings rate. In theory, excess German savings could have left Europe; but, given high Asian savings that already had to be absorbed, mainly by the US, and the constraints imposed by the euro, it was almost inevitable that excess German savings would be exported to other European countries.

Germany should care about Spain’s difficulty in adjusting, because the resulting rise in European unemployment will be absorbed mostly by Spain unless the Spanish government accelerates the adjustment process by leaving the eurozone and devaluing. In that case, Germany would bear the brunt of the rise in unemployment.

There should be nothing surprising about this. Once deficit countries take aggressive measures, it is usually trade-surplus countries that suffer the most from international crises caused by trade and capital flow imbalances. As political tensions in low-savings countries grow, so will the risk of these countries abandoning the euro, causing the price that Germany will pay for its distorted savings rate to rise.

This article is based on the author's recently published book The Great Rebalancing (Princeton University Press).

Read more from our "Zone Defense" Focal Point.

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (16)

    Please login or register to post a comment

    1. CommentedJim Kelley

      It is not really savings when someone else consumes it. There is negative global savings, considering the draw on resources. There needs to be real savings for any real stability. Someone, somewhere has to actually forego consumption, not consume vicariously. Exchange rates can only help very modestly. Where is Jonathan Swift when you need him? This time feed the gentlemen to the children.

    2. CommentedDunken Brain

      Factually incorrect!?
      "Germany’s large trade deficits in the decade before 2000 subsequently swung to large surpluses,...."

      As far as I can see, according to the German Federal Statistical Office Data, Germany has only "dipped" into exceptionally small trade deficits during the three decades 1971-2000.
      Do you honestly want to call these "large trade deficits"?

      The data can be easily visualized at:

      Please correct me where necessary

        CommentedJose araujo

        1-2 % of GDP isn't, IMHO, a large current account deficit, Portugal is running at 6,4, Turkey 9,9, etc.

        Current account= balance of trade , factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers, so I stand corrected and Investments in the eastern republics aren't a part of the current account.

        And yes there was a "marked improvement in the German current and trade accounts at the same time that there was marked deterioration in the current and trade accounts of France and the PIIGS."

        Which IMHO is explained by China entry in the WTO in 2001 and the Euro implementation in 1999.

        CommentedStephen Upton

        According to this, Mr. Araujo

        Germany ran current account deficits of 1-2 percent of GDP every year except one in the 1990s. I don't know the numbers for other countries, but these strike me as quite large in nominal terms and should probably show up often enough as among the largest in the world.
        After 2002 they average in surpluses of about 5 percent of GDP (I am only eyeballing, so this isn't exact). This is a shfit of, on average, 6 precent of GDP in the decades before and after 2001. That must be a huge shift, and I think it supports the Pettis argument.
        I am not sure why investment in the eastern republics would show up in the current account. Isn't that a capital account transaction?
        As for worker remittances, which I think you mean, I think these would indeed show up in the current account, but unless they fell off substantially in the 2000s, I am not sure the numbers would undermine the argument made by Pettis that there was a large shift in Germany's current account around 2001 that coincides with the large shifts in the current accounts of Spain and other PIIGS.
        I remember seeing some numbers in The Economist that showed a marked improvement in the German current and trade accounts at the same time that there was marked deterioration in the current and trade accounts of France and the PIIGS. I can't find the article now, so I may be wrong, but if Pettis is wrong one place it would show up might be in the lack of relative changes in the trade and current account positions. Is that what you are suggesting?

        CommentedJose araujo

        Germany never had large trade deficits nor large current account deficits. Actually I think with the exception of beginning of the 90's Germany always had trade surplus, the small current account deficits were explained by money transfers (immigrants and direct investments in the eastern republics)

        CommentedStephen Upton

        Elsewhere he has said that it is the current account, not the trade account that swung from deficit to surplus, which makes sense since the difference between savings and investment is the current account, not the trade account. I wonder if there was a tight word-count requirement. I've made that mistake before too.

    3. CommentedJose araujo

      Spanish average growth rate between 1988 and 1999=7%
      Spanish average growth rate between 2000 and 2009=4,3%

      Spain didn't boom because of "German savings", quite the opposite

    4. CommentedJose araujo

      There isn't such a think as savings, in order for savings to exist someone must be investing or consuming. Savings don't represent a stock of resources, they are just bits and bytes on a system.

      When you buy a stock on the second market, are you investing, or are you consuming an investment good? There is no investment counterpart, because that investment was already made.

      In the end, Germans were/are consuming Spanish investment goods that in turn were consuming Germans durable goods. It turns out Spanish investment goods lost value, but that's the nature of the game when you buy stuff.

      If Germany had saved less, by paying its workers their fair share of the trade surplus, instead of consuming spanish investment goods, they would be consuming spanish durable goods, and the problem would be solved.

      If Germany instead of consuming investment goods in turn invested in Spain, Spanish savings rate would increase because there would be more money in Spain, more Spanish goods to be bought.

      If it turns out Spanish investment goods have less value, bad break for the Germans, that's what happens when you buy investment goods. Next time just buy German goods or invest directly in Spain

    5. CommentedRobert Pringle

      What matters is not saving but financing. Countries running current account surpluses do not finance those running current account deficits.The deficits are financed by banks, investors and other suppliers of funds.

      Analysis confined to national account concepts like savings and investment throws no light on the cross-border flows that actually finance credit booms. Indeed, it diverts attention away from the monetary and financial factors that are the main cause of financial crises; see

    6. CommentedSteven Tolliver

      Traditionally in Spain the main savings vehicle has been home ownership, which involves taking out a mortage and hence is termed as borrowing. To be sure, home mortages in Spain cannot account for all the private debt taken on in the past 15 years, but this cultural trait should be taken into account before labeling all of Spain as profligate.
      Having lived in Spain for many years, I can assure you that people here are not at all lazy. They are, however, caught up in a system that is highly inefficient.
      Ideally, Spain could devalue its currency to help resolve the debt problem. But the designers of the Euro failed to incorporate any sort of intra-euro adjustment mechanisms, so the bond market had to create one in the form of the risk premium vs. German bonds.
      And as for leaving the Euro, since there is no known way to do that, either, the amount of pain and suffering that would be borne by the average citizen would likely be huge.

    7. CommentedSarchis Dolmanian

      It seems that Professor Pettis is one of the very few people around who realizes that 'borrowing' is a relation between TWO entities, the creditor AND the debtor.
      Most of the punters keep talking about the profligacy and recklessness of the debtors but almost no one speaks anything about the responsibility of the creditor: why on Earth make available (a lot of) money to somebody and then place the whole responsibility on the side of the debtor?
      Where was the creditor when the deal was struck?
      If one would examine this problem from the other side it would very quickly become crystal clear that 'a pound of flesh' (practically all that one can get from a bankrupt debtor) is a lot less useful than a portion of the initial sum .
      In this light creditors should refrain from extending careless credit but, a lot more important, from the debtor point of view it would seem irrational not to take the offered credit, no matter if paying back seems feasible or not.

    8. CommentedProcyon Mukherjee

      I am not very sure on the conclusion that the it is the 'distorted' high savings rate of Germany that is the root of the problem and that the profligacy of low savings and high deficit culture of some of the Southerners in Europe have no accountability for the problems that have followed in the post crisis period.

      It would be worthwhile to simply go through the towns of Spain and Germany to see the difference of what profligacy can do (in the Spanish case) and on the other hand what prudence can deliver (in the German). It is simply the comparison of the number of Town Halls per person and their pomp that would tell everything. The rail and road connectivity is the next one, where one should see the investment per passenger (rail) and the investment per car (road).

      All this has very little to do with Germany's high savings rate. It is simply the way Germans want to look at their future and the Spanish want to fritter away.

        CommentedStephen Upton

        Sorry, but I thought my first comment was lost, so I tried to rewrite it.

        CommentedStephen Upton

        But if Spain had excess capital forced upon it at excessively low interest rates, wouldn't wasted investment have been the result in any case? This is always what happens, whether in Spain, Germany, or anywhere else. If the Germans could not find any good use for their excess savings, and they dumped them on Spain, and the Spaniards could not dump them on someone else because of the restrictions imposed by monetary union, why blame the Spaniards for not finding a good use for the German money which the Germans could not find either?

        CommentedStephen Upton

        But he makes the point that excessively low interest rates and excess capital always results in wasted investment, and so it isn't surprising that Spain reflected the impact of those excesses. After all if the German's couldn't find a good use for their savings and they dumped it on the Spaniards, and the Spaniards were unable to dump it on anyone else, why should they be criticized for not finding a better use for it when the Germans couldn't either?

    9. Portrait of Pingfan Hong

      CommentedPingfan Hong

      Savings are not the causes of any financial crisis, but the misusing of the savings by the financial sector, or the debtors.