Sunday, April 13, 2008

Evidence on the Savings Glut Hypothesis

A country's current account is the difference between its saving and investment: a country with a current account surplus is saving more than necessary to finance its domestic investment. The difference goes to purchase foreign assets, a so-called "capital outflow." In recent years, the US has been running large current account deficits ($739bn or 5.3% of GDP in 2007), which means US savings is not sufficient to finance domestic investment and the difference is made up by selling US financial assets to foreigners (i.e. the US has a net capital inflow).

In 2005, Ben Bernanke offered a novel hypothesis that the US current account deficit was driven by a "savings glut" in the rest of the world, especially in emerging market countries. The current account surpluses of the emerging countries were used to purchase US assets, contributing to high US share prices and housing values (due to long-term interest rates kept low by the inflow of foreign saving into the US bond market). This increase in the wealth of US households drove the low savings rate - i.e., US households felt they could consume more because of the increases in home equity and stock prices.

On his blog, Brad Setser provides some evidence in favor of the savings glut hypothesis:
In 2007, the savings rate of the emerging world savings was almost 10% of GDP higher than its 1986-2001 average. Investment was up as well – in 2007, it was about 4% higher than its 1986-2001 average. However the rise in the emerging world’s savings was so large that the emerging world could investment more “at home” and still have plenty left over to lend to the US and Europe. That meets my definition of a “glut.”...

The big drivers of this trend. “Developing Asia” and the "Middle East." Developing Asia saved 45% of its GDP in 2007 -- up from 33-34% in 2002 and an average of 33% from 1994 to 2001 (and 29% from 86 to 93). Investment is up too. Developing Asia invested 38% of its GDP in 2007, v an average of between 32-33% from 1994 to 2001. Investment just didn't rise as much as savings. The Middle East also saved 45% of its GDP in 2007 – up from 28% of GDP back in 2002 and an average of 25% from 1994 to 2001 and an average of 17-18% from 1986 to 1993. Investment is up just a bit -- at 25% of GDP in 2007 v an average of 22% from 1994 to 2001.
The Middle East oil producers appear to behaving in a manner consistent with the permanent income hypothsesis - if the current high oil prices represent a transitory increase in their income, an increase in saving will allow them to spread the increase in consumption over a longer time period.

The current account surpluses of "Developing Asia" (most prominently, China) are harder to make sense of. If these countries expect higher income in the future, the logic of consumption smoothing implies they should be borrowing today. Moreover, conventional assumptions about production technology imply the returns on capital should be higher where capital is scarce - i.e. capital should flow from the US (with has a large capital stock and therefore should have a low marginal product of capital) to the developing countries, rather than in the other direction (this previous post discussed the perversity of a poor country - China - lending to a rich one - the US).

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