Thursday, November 27, 2014

Why Are Savings Patterns So Different?

BEIJING – Ever since the integration of emerging markets into the global economy began in the early 1990’s, three striking trends have emerged: a divergence in private savings rates between the industrialized core and the emerging periphery (the former experiencing a sharp rise, and the latter a steady decline); large global imbalances between the two regions; and a drop in interest rates worldwide. But, while global imbalances have preoccupied many observers, few have sought to explain the divergence in world savings behavior.

In 1988, the household savings rate in China and the United States was roughly equal, at about 5%. Yet, by 2007, China’s household savings rate had risen to a staggering 30%, compared to just 2.5% in the US. The pattern is not uncharacteristic of other industrialized countries relative to emerging markets over the last two decades (Figure 1).

Savings behavior invariably reacts to changes in interest rates, which have fallen steadily over the last two decades to today’s record-low levels. But how can savings patterns be so different – often opposite – in globalized economies that are well integrated into world capital markets?

The answer may be that credit markets are more developed in advanced economies than they are in emerging countries, particularly in terms of the degree to which households are able to borrow. Of course, one might argue that Asian thrift and American profligacy merely reflect asymmetric demands for credit: Asians are intrinsically more reluctant to borrow. In that case, however, the vast differences in household debt (Figure 2) – ranging from 25% of GDP in emerging Asia (Southeast Asia, China, India, Hong Kong, and South Korea) to more than 90% in the US and other Anglo-Saxon economies (including Australia, Canada, Ireland, New Zealand, and the United Kingdom) – would reflect only a dissimilarity in taste.

A more plausible explanation is that institutional differences in the ability to borrow dictate to some extent the disparity in savings rates across countries. The argument is simple: All economies have both borrowers and savers, and changes in the cost of borrowing (or the return to saving) affect them differently. When interest rates decline, borrowers are able to borrow more. Savers, on the other hand, may be compelled to save more in the face of shrinking interest income.

At the macro level, a less credit-constrained economy (with a large mass of effective borrowers) could then experience a fall in the savings rate as borrowing rose. However, in a country with a large mass of effective savers, the savings rate can rise, rather than fall. This asymmetry in savings patterns might thus reflect the simple fact that credit-constrained economies are less sensitive to drops in the cost of borrowing relative to less constrained economies.

In joint research with Nicolas Coeurdacier and Stéphane Guibaud, we show that economic data supports this view. Borrowers and savers are naturally grouped by age. The young normally face low, current wage income, but faster growth in future income, and would ideally borrow against future income to augment consumption today and to invest in education. The middle-aged, preparing for retirement, are likely to be the economy’s savers. If asymmetric credit constraints are indeed important, young borrowers and middle-aged savers will display distinct patterns in constrained versus less-constrained economies.

In fact, there was a remarkable contrast in savings behavior across age groups in China and the US in the period 1992-2009. For young Americans (those under 25), the borrowing rate rose by ten percentage pointsmore than the borrowing rate of young Chinese, while the savings rate of the Chinese working-age population (ages 35-54) rose by about 17 percentage points more than the savings rate of their American counterparts.

Another implication of this view is that the steep rise in savings in China is largely driven by a rise in the savings rate of middle-aged Chinese (rather than a fall in the borrowing rate of the young). Conversely, the fall in savings in the US is largely due to higher borrowing by the young (rather than a fall in middle-aged Americans’ savings rate).

Indeed, of the 20.2-percentage-point increase in aggregate household savings (as a share of GDP) in China from 1992 to 2009, the middle-aged cohort accounted for more than 60% (the remainder was largely attributable to the elderly). In the US, which experienced a 1.8-percentage-point decline in aggregate savings as a share of GDP, the savings-to-GDP ratio among the young declined by 1.25 percentage points, whereas the figure for middle-aged savers actually increased by about 1.5 percentage points.

Apart from accounting for the global divergence in savings rates, tight credit constraints in China might explain the country’s high, and rising, savings rate – especially as the large rise in national savings is attributable mostly to household savings. This would mean that China’s much-publicized effort to boost domestic consumption might in fact call for appropriate credit-market reforms.

US Federal Reserve Board Chairman Ben Bernanke’s notion of a “global savings glut” is a commonly cited explanation for falling world interest rates. Credit constraints in fast-growing developing economies may be the reason why the glut emerged in the first place.

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    1. CommentedScott Urban

      Moreover, large savings-investment gaps pre-1997/98 (Asia crisis) suggest that dissaving is not unprecedented in these economies, even relatively recently. (But it also means the author might better describe the 'savings glut' phenomenon as beginning in 1998 (not the "early 1990s"). Still, a great article. Thanks.

    2. CommentedAshis Kumar

      Interesting study Keyu ! Is the rationale valid for India as that for China? i.e. the savings rate of Indian working rate population increased with a decrease in interest income?

    3. CommentedMoritz G€d1g

      Savers save MORE if the interest rate is high and they save MORE if the interest rate is low.
      I do not disagree, but point out how simplistic the assumptions in some?most?all economic models and arguments are, because they usually assume that only higher interest rates increase saving. Obviously it depends on the state of the economy (outlook) and the government retirement program, both it's facts and trust in it's future.

    4. CommentedDaniel Gomes

      It's appalling how can a scholar do a comparative analysis of savings rates across different countries without taking into consideration the different levels of formal and informal social security nets, in particular concerning poverty, health, retirement and unemployment.

      Asia's export driven economy is sustained by two factors:
      - Currency devaluation to dump export prices
      - Policies promoting a continuous inflow of cheap labor to manufacturing hubs

      As everyone in Asia knows, the huge armies of exploited migrant workers who typically leave their families behind and are denied residence rights in the cities where they work, have one single goal when they migrate, to earn and save as much as possible and retire to their home town after their employers have extracted all the productivity they could and replaced them with cheaper newer more productive specimens.

      So of course their savings rates will be much higher.

      On the other hand countries who provide a reasonable level of social security will have much lesser need to save for a rainy day as to different extents, education, health, unemployment and retirement allow the citizens a much higher level of peace of mind , thus allowing them to save lesser for a rainy day.

      Also in most asian countries that I know, Singapore, Malaysia, China a significant percentage of the personal mandatory savings scheme managed by the government, must be allocated to housing expenses.

      Meaning that most people in these countries will withdraw their mandatory savings to buy a house instead of applying for credit, because otherwise those savings will evaporate with inflation as the intrest paid by the gov is way too low.

    5. CommentedRoss Clem

      Low interest rates may induce savers to save more to maintain income or to spend savings because the return on savings is so low there is no incentive to save.