A short overview of National Savings and Investment

by Ken Morris 26.OCT.07

This is one in a series of articles written to commemorate financial literacy month. Since the other topics in the series, such as “Why Save” and “Saving for your Future” are likely to be addressing those issues from a microeconomic perspective, I have chosen to deal with this important issue of Saving and Investments from a Macroeconomic perspective. Consequently, I would aim to give readers, particularly ‘the layman’, in as few words as possible, an idea of what constitutes National Savings and Investments, and in a simplification of reality explain some macroeconomic impacts of National Savings and Investments. By way of background information, it is important to look at the concept of National Income.{{more}}

THE CONCEPT OF NATIONAL INCOME

I guess everyone would have heard the term GDP before. It stands for Gross Domestic Product, and this is the total value of all final goods and services produced in a country over a period of time, usually one year. GDP is reported in current and constant prices, and is used world-wide as one of the main measures of economic activity.

GDP measures domestic but not National Income. In order to arrive at national income, we have to add to GDP what is called Net Factor Income from abroad. This Net Factor Income from abroad, in the case of SVG, consists of any income earned by Vincentians on factors of production located abroad, minus any payments made abroad for the use of foreign factors of production. This will give us the Gross National Product (GNP) or the National Income.

NATIONAL SAVINGS AND INVESTMENTS

National Savings is not just the amount held in bank accounts by individuals, businesses and the government. Instead, the National Savings consist of, firstly, private sector savings, i.e. savings by households and business enterprises. Secondly, it consists of public sector savings, represented by the government’s current account (fiscal) deficit/surplus or the difference between the government’s recurrent expenditure and recurrent revenue (G-T). The third source of National Savings is the foreign sector. This represents any net borrowing by our country from the rest of the world, and implies a corresponding external current account deficit. What I am saying here is that our utilization of foreign savings forms part of national savings, and is represented by net export or the difference between exports and imports of goods and services. So that if net export is negative, then this means that we are utilizing foreign savings, but if it is positive, it means that we are instead providing savings, to foreigners or the rest of the world.

Similarly, National Investment is the total amount of Investment undertaken by firms, individuals, the government and foreigners in a particular country, and includes mainly investment in fixed capital formation, i.e. the purchase or construction of productive plant and equipment, but can also include investment in inventory or stocks.

SOME IMPACT OF SAVINGS AND INVESTMENTS

Since the national savings is the sum of private sector, government sector and foreign sector savings, then if private savings is low, the country will have to finance investments by either government savings or with foreign savings. So that, if private savings is low and the government is running a current (fiscal) deficit, this means that the amount of government savings is in fact negative, then the only way to finance a high level of investment will be to maintain a high level net imports i.e. to borrow from foreigners or the rest of the world, which essentially means running a large Balance Of Payment (BOP) Current Account deficit.

The difficulty with financing investment through foreign savings rather than through domestic savings is that the country ends up accumulating foreign debt, which brings with it interest and exchange rate risks. If a country runs a Current Account deficit as is the case in many developing countries, then this means that the country is borrowing from the rest of the world, and its foreign debt will increase over time. So we are seeing how low levels of domestic savings can lead to a rising debt problem which, if unsustainable, can hamper economic growth or the growth rate of GDP.

However, if the government is running a current (fiscal) deficit, the country may not necessarily have to borrow from abroad, if the level of private sector savings is sufficiently high to accommodate the level of investment. It shows here the importance of private sector savings and also why it is important that governments try to run current account (fiscal) surpluses to augment savings from the private sector instead of depending on foreign savings which as we established above can compromise future economic activity through interest rates and exchange rate problems.

Following from above, we have, therefore, established a connection between the National Savings and Investment and the Current Account Balance of the Balance Of Payment (BOP). We have seen that if there is an increase or decrease in domestic savings or investment that this affects the level of National Savings or National Investment. We also saw that this can have implications for the Balance of Payment (BOP) of the country, and more specifically the Current Account Balance, which will go into deficit when there is a fall in the domestic component of National Savings, in other words, when there is a fall in private savings and or an increase in the government current account (fiscal) deficit.

The external current account may also go into deficit when (other things being equal) there is an increase in National Investment or an increase in domestic investment that exceeds domestic savings. But a current account deficit caused by a boom in investment, even though it may involve an accumulation of foreign debt, is not necessarily a bad thing. As long as the new investment projects are profitable, so that over time the goods produced by the new capital will lead to increased country exports that will generate trade and current account surpluses that are necessary to eventually repay the foreign debt and interest on it.

In summary, it is critical that we realize that it’s the citizens of a country that are responsible for the domestic component of National Savings and Investment. I hope that we’ve seen that it is important from an individual business and governmental level that we strive to increase the level of domestic savings in order to accommodate greater levels of National Investment, which are essential for economic growth and development in any developing country like St.Vincent and the Grenadines.

This article was submitted in support of Financial Literacy Month