PER 2015
Saving our skin Hamish Lloyd Barnes "High saving promotes faster growth. So having more savers in the global economy should be good for our long run prosperity." Encouraging individuals, firms and governments alike to pocket their cash for a rainy day has become a regular mantra amongst economists of late, but is there any truth behind this obsession over thrift? Fundamentally, the debate that ‘having more savers in the global economy should be good for long run prosperity’ is a twofold, hinging on two conflicting arguments; the Keynesian ‘paradox of thrift’ which argues that a high savings ratio will lead to a lack of demand, potentially resulting in less investment and thus poor economic growth via the accelerator theory and the opposing Classical ideology that savings are borrowed and used to fund investment, causing the productive capacity to grow. John Maynard Keynes argued in his ‘General Theory’ in 1936 that a large rise in savings would in turn trigger a slump in aggregate demand as consumption begins to fall; a concept which he coined a ‘paradox of thrift’. The paradox describes the decision a consumer or firm faces when they receive their income (or revenue); to save or spend? Of course, the opportunity cost of saving or spending respectively can vary in a given economic climate and in different time periods, presenting consumers, firms and governments with a vexed conundrum. The allure of spending is the prospect of immediate satisfaction in the form of good and services, whereas savings promise a buffer for future years and economic security for the individual. Weak demand can then lead to a decline in investment, as firms near their capacity do not feel the need to expand via capital investment due to low levels of demand; this phenomenon is known as the accelerator theory. Such an issue tends to be more prominent in times of economic slowdown, or recessions, when falling GDP growth and rising unemployment forces the government and individuals alike to save their incomes, making demand weaker and triggering a prolonged period of negative growth. A popular analogy links the dilemma which Keynes’ paradox presents to consumers to the iconic words of St Augustine; “lord give me chaste, but not yet” 1 , but are high savings ever wholly necessary? It is important to note that there are different forms of saving; private savings, which is the sum of savings by companies and by individuals, and government savings, defined as government revenue less current expenditure. A rise in ‘global savers’ implies that both government and private sector saving increases, which is unlikely due to a concept known as ‘Ricardian Equivalence’ which suggests that cuts in public sector spending are offset as the private sector begins to flourish as households reap the rewards of lower taxation. A rise in saving will only lead to a fall in aggregate demand if national saving; the sum of private and public saving, increases. Moreover, a fall in aggregate demand could lead to demand pull deflation in the long run, depending on the amount of spare capacity in the macroeconomy assuming you adopt a Keynesian LRAS curve, that is. If the price level falls relative to global economies, this could lead to a fall in imports as foreign goods and services become comparatively more expensive than that of domestic products and a rise in exports as they become more competitive. If this surge in exports and fall in imports outweighs the initial rise in national savings, then demand side growth could be stimulated in the long run. In the long term, it is argued that large levels of savings can be used to finance investment, defined as the addition of fixed capital by firms, which in theory should lead to a rise in the productive
1 Augustine of Hippo, Confessions (c.397) VIII, 7
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