The visible hand in economics

Archive for the ‘Productivity series’ Category

So far we have described that there is some belief that we have some problems in our capital market, this has lead to the statement that we have a “savings problem” and to solve it the government introduced Kiwisaver – which may not even increase national savings (infact it might reduce it). These articles have put us at a point now where we can ask – even if Kiwisaver does not increase national savings, could it do any good.

As mentioned in this post, our “savings problem” may not stem from insufficient savings per see, but from distributional issues surrounding our savings. As Dismal Soyanz suggests, other government policies (or insitutionalised rules of thumb) may have created a situation where savers have a bias towards relatively “unproductive” forms of investment, such as housing – furthermore, households underestimate the risk of certain assets and overestimate the risk of others. These are all behavioural biases that may exist in reality – as a result of the bounded rationality of individuals.

As a result, the purpose of Kiwisaver may be to shift the composition of New Zealand’s savings – not increase the level. Now if this is what Kiwisaver is meant to achieve we have to ask about two things – firstly, is there a better alternative. I can’t think of too many alternatives off the top of my head, so I’m going to cover this by asking, how does Kiwisaver compare to a straight income tax, where some % of the money is put aside?

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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?

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In another of our warm up posts for discussing productivity we are going to discuss why national savings are important.

As Fred states in this comment, savings are effectively deferred consumption. The incentive to defer consumption is based on individuals wish to “smooth consumption” over time (which relies on their time discount rate and expectations of future income) and the return available on these savings. Now the reason that it is possible to make money off your savings is because these savings are used by other agents in the economy who have the ability to pay you back later on – fundamentally these savings are used to invest.

Going back to our good friend supply and demand we know that the supply of funds for capital investment is a function of the interest rate and peoples willingness to smooth consumption while the demand for capital investment is a function of the interest rate and the expected return from the investment. As savings increase in the interest rate (for those who care, assume that the substitution effect dominates the income effect of a higher interest rate) and investment decreases with the interest rate (or at least the expectation of the equilibrium interest rate) we know that there will be an interest rate that makes supply and demand equal.

Fundamentally, the government may want to increase national savings if they believe that current national capital accumulation is sub-optimal for some reason – as in some sense savings=investment. Again I’m going to ask a question which I would love for everyone to have a go at answering – why may the government believe that the current rate of capital accumulation is sub-optimal?

Over at the NBR comment page Trinh Le from NZIER discusses the research by John Gibson and herself into Kiwisaver and aggregate savings (here and research).

The idea that Kiwisaver can actually reduce national savings is an important one – and something that one of us will post on soon, either before or during our upcoming discussion on productivity.

For now it would be useful for you guys to have a look at this article and tell us what you think. Do you think Kiwisaver will actually increase national savings – if so (or not) why?

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