What is this savings problem?
Posted May 28, 2008on:
So far we have discussed Kiwisaver and national savings in fairly loose terms. We know that (part of) the purpose of Kiwisaver was to increase national savings and that our interest in national savings stems from the fact that we want New Zealand to have more productive capital.
So before we can discuss the myriad of burning questions surrounding these issues – and more broadly surrounding New Zealand’s productivity (such as if Kiwisaver achieves the greater capital goal even if it theoretically doesn’t increase savings) we need to ask, what is the savings problem?
David Skilling from the New Zealand Institute has written widely about the “savings problem” New Zealand faces. In his view we can tell that New Zealand national savings levels are low as our current account deficit is so high, our business investment is so low, our foreign direct investment is stagnant, and domestic investment in the local stock market is limited. This sets the stage for the savings problem to be defined as follows:
National savings levels in New Zealand are too low
However, the existence of a current account deficit is not evidence that savings are “too low” – it is only evidence that domestic expenditure on consumption and investment is greater than domestic income! This view is in evidence in both wikipedia and recent work by NZIER and Capital Economics Ltd. As a result, as long as consumption and investment are determined by individuals with sufficient freedom to make choices and there are no externalities and sufficiently good information and institutions in the country it seems a bit silly to say that savings is “too low” – savings will be determined such that individuals are maximising their lifelong expected utiltiy!
Furthermore, as Trihn Le from NZIER says:
the saving-investment-growth issue relates to national saving rather than household saving. New Zealand’s national saving rate has been largely positive and shows no sign of deteriorating
Remember, the purpose of saving is deferred consumption – if we invest in something it is so we can consume from it later! When describing the savings level we want it is important to look at national savings – not private savings, as that defines the level of true savings in the economy.
As a result, when discussing savings and investment we are talking about the trade-off between consumption now and consumption in the future. If we want more stuff in the future, we will have to sacrifice some consumption now. Rather than having government legislate the timing of our consumption, wouldn’t it be fairer to let people decide for themselves.
It is still possible that we can have problems with savings. Fundamentally they fall into two categories:
- Market failure causing a sub-optimal level of savings,
- Market failure causing a sub-optimal distribution of savings.
Starting with the level argument it is important to look at the possibility of poor institutions and externalities. If the institutions aren’t up to scratch, the wedge between the return on investment and the return on savings will be greater – leading to lower levels of investment.
The externalities argument is more difficult. If we know that there are positive spillovers from investment, then extra savings may increase the return from further investment, leading to a significant increase in investment intentions and demand for capital. If this is the case we will have multiple equilibrium and government policy may be able to move us to a pareto superior outcome.
Furthermore, if we think there is a negative externality from consumption (by consuming you make other people feel bad about their lives) a higher savings equilibrium would be preferable – although I am not a big fan of this argument! (Update: CPW mentions that his doesn’t make sense – as since savings is deferred consumption we have to face the externality anyway. He is right. However, we can still justify looking at this externality if the marginal social cost rises in consumption and we have consumption tilting, which requires that the rate of time preference is greater than the interest rate)
The suboptimal distribution of savings is a FAR more important issue. This stems from asymmetric information. Fundamentally, New Zealander’s seem to hold an underlying belief that investment in housing is the best type of investment. Now, buying a house is definitely an investment with a return (rent or imputed rent as well as capital gain through the opportunity cost of land and other scarcity issues) that appears relatively low risk and has fringe benefits (its hard to get kicked out of a house once you own it).
However, our focus on housing seems to be a bit extreme as noted by the RBNZ.
As a result, a savings problem in terms of the distribution of savings that households have undertaken may well exist in New Zealand – this raises the question, will Kiwisaver help solve this problem?
(Update: Hone rightly mentions that time inconsistency is a problem that the government may want to solve when it comes to the savings decision – this is another reason why savings may differ from what is socially optimal).