Debate about the global savings glut hypothesis is mired in confusion, a fundamental part of which is the seemingly obvious but false claim that a global savings glut must lead to higher global savings.Here, for example, is a recent piece by one of my favorite economists, Barry Eichengreen:
There is only one problem: the data show little evidence of a savings glut. Since 1980, global savings have fluctuated between 22% and 24% of world GDP, with little tendency to trend up or down.
As surprising as it might sound, global savings gluts do not result in higher global savings except under specific, often unlikely, conditions.
What is a savings glut?
There is no formal definition, but whenever market conditions or policy distortions cause the savings rate in one part of the economy to rise excessively (itself an ambiguous word), we can speak of a savings glut. There are at least two main causes of a savings glut.
- A rise in income inequality. We see this in Europe, the US, China, and indeed in much of the world. As wealthy households increase their share of total income, and because they tend to save a larger share of their income than do ordinary households, rising income inequality forces up the savings rate.
- A decline in the household share of GDP. We’ve seen this mainly in China and Germany over the past fifteen years. When countries implement policies that intentionally or unintentionally force down the household share of GDP (usually to increase their international competitiveness) they also automatically force down the consumption share of GDP. Because savings is defined as GDP minus consumption, forcing down the consumption share forces up the savings share. There are many policies and conditions that do this, and I discuss these extensively in my book, The Great Rebalancing, but the main ones are low wage growth relative to productivity, financial repression, and an undervalued currency.
Notice that in both these cases, and completely contrary to the popular narrative that praises high savings as a consequence of household thrift, and so as morally virtuous, the rise in the savings rate does not occur because ordinary households have become thriftier. In the former case household savings rise simply because the rich increase their share of total income. In the latter case national savings rise without households in the aggregate increasing their savings.
How does the economy balance?
An economy’s total production of goods and services (GDP) can be defined either from the demand side (consumption plus investment) or from the supply side (consumption plus savings). By definition, in other words, savings is always exactly equal to investment.
An economy experiencing a savings glut must maintain this balance. It is consequently just a matter of logic that a savings glut must be accompanied by a balancing adjustment – either by an increase in investment or by a reduction in savings in another part of the economy – and this adjustment must occur simultaneously. The necessary implication is that whatever causes the savings glut must also cause one or both of these balancing adjustments.
There are only two ways investment can rise and two ways savings elsewhere can drop. This means that a savings glut must result in one or more of the following, enough fully to offset the savings glut:
- If productive investment has been constrained by the lack of savings, productive investment will rise.
- Nonproductive investment can also rise. Excess savings can cause large speculative flows into real estate or other assets, perhaps even setting off asset “bubbles”. When this happens it can create additional investment outlets for excess saving in the form of projects, including most often real estate projects, whose economic value can only be justified by rising price expectations.
- Rising asset prices can unleash a consumption boom if it causes ordinary households to feel wealthier and so increase their consumption (the “wealth effect”). This increased consumption creates what I will call, perhaps clumsily, a “consumption glut”.
- If less consumption caused by the savings glut is not matched by higher investment or by a consumption glut, total demand drops, resulting in higher unemployment. Unemployed workers stop producing goods and services but do not stop consuming. Because savings is simply the gap between production and consumption, unemployment causes the savings rate to drop.
Economists almost always miss this point. A global savings glut must be accompanied by one or more of the four adjustments listed above. It can result in higher global savings if the economy rebalances in the form of higher productive or unproductive investment, or it can result in no change in the global savings rate if the economy rebalances in the form of a consumption glut or a rise in unemployment. Nothing else is possible.
The best outcome is if a savings glut is accompanied by higher productive investment. This is often referred to as “trickle down economics” when both the rich and the poor benefit from productive investment, with the rich benefitting more.
If there is a savings glut, will productive investment automatically increase? If productive investment has been constrained by low savings it will, but productive investment tends to be constrained by insufficient savings mostly in undeveloped countries. Most excess savings, however, have originated or flow into rich countries.
In rich countries there are often many productive projects that desperately await investment, but this failure to invest is driven by other factors, and usually not by the lack of savings, so that a savings glut is unlikely to lead to higher productive investment*. Former Fed Chairman (1934-48) Marriner Eccles even argued that a savings glut could reduce productive investment. “By taking purchasing power out of the hands of mass consumers,” he wrote, “the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants.”
More commonly when excess savings are high they flow into real estate and stock markets, perhaps even setting off bubbles, with overinvestment in real estate an almost inevitable consequence of rapidly rising housing prices (we saw this most obviously in peripheral Europe, the US and China). These speculative flows have another impact that allows the economy to balance savings and investment. The real estate bubble makes households feel wealthier, which encourages a consumption glut, so that between the real estate boom and the consumption glut, the savings glut is fully absorbed.
But this is temporary. When the asset bubbles burst, the resulting surge in unemployment brings down the savings rate enough again to maintain the balance between savings and investment.
Savings must balance
The point here is that a savings glut need not result in an overall rise in savings. It can just as easily cause a consumption glut elsewhere whose positive impact on total demand fully mitigates the negative impact of the savings glut. The idea however that a savings glut can simultaneously create a consumption glut seems to be one of the most difficult things for many economists to understand, perhaps because it seems at first so counterintuitive.
Of course the other way a savings glut need not result in an overall rise in savings is through higher unemployment. In fact because neither an asset bubble nor a consumption glut is sustainable, unless productive investment has been constrained by a lack of savings, the only long-term consequence of a savings glut is a rise in unemployment and no rise in total savings.
In that case there might be only two sustainable ways to address the resulting unemployment. Either the savings glut is reversed, or governments act to eliminate whatever were the previous constraints on productive investment (perhaps by liberalizing constraints to investment or even by initiating a kind of “new deal” in infrastructure investment). The third way, although not sustainable, is for another asset bubble to be inflated so as to encourage another consumption glut, which seems currently to be the preferred way of US and European governments.
Which way is the causality?
It is just a matter of logic that unless investment rises substantially, a savings glut must combine with a consumption glut or with a surge in unemployment so that there is no net increase in savings. But logic only tells us that the two must occur simultaneously. It implies no obvious direction of causality. Does a savings glut cause a consumption glut, or does the consumption glut cause the savings glut? To put it in contemporary terms:
- Did Chinese policies aimed at forcing up domestic savings (by forcing down the household income share of GDP) set off a consumption glut in the US, or did profligate US consumption require that Chinese savings rise to accommodate it?
- Did German policies aimed at restraining workers’ wages force up the German savings rate, with excess savings pouring into peripheral Europe, setting off real estate bubbles, which then set off consumption gluts, or did over-enthusiasm about the euro cause overly confident citizens of countries like Spain to embark on a consumption binge, which could only be balanced by a rise in the German savings rate?
One way of resolving these questions might be to examine the cost of capital. Pulling capital from low-savings to high savings parts of the economy might seem to require high interest rates. Pushing capital from high-savings to low-savings parts of the economy might seem to require low interest rates.
There is so much misunderstanding about the savings glut hypothesis that much of the debate has verged on the nonsensical. Unless it unleashes a truly heroic surge in investment – productive or nonproductive, although the latter can only be temporary – a savings glut must always be accompanied either by a consumption glut elsewhere or by a rise in unemployment. No other option is possible. This is why savings gluts rarely result in higher overall savings.
This is also why any serious discussion of the savings glut must eschew moralizing and must focus instead on the direction of causality. Did distortions that created a savings glut force the creation of a consumption glut, or did distortions that created a consumption glut force the creation of a savings glut? Any analysis that does not recognize that both must occur simultaneously, and so must be resolved simultaneously, cannot possibly be correct.
* Perhaps in cases in which investment has been constrained by high interest rates, higher savings can unleash more productive investment. It may also be, although I cannot prove it, that when income inequality is low, higher savings associated with further increases in inequality can lead to more productive investment in part because interest rates might be high. In that case it would seem that when income inequality is high, higher savings associated with further increases in inequality will not lead to more productive investment.
This piece is cross-posted from Michael Pettis’ China Financial Markets with permission.