Arnold Kling  

Saving and Identities

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Yves Smith and Rob Parentau write,


Over the past decade and a half, corporations have been saving more and investing less in their own businesses. A 2005 report from JPMorgan Research noted with concern that, since 2002, American corporations on average ran a net financial surplus of 1.7 percent of the gross domestic product -- a drastic change from the previous 40 years, when they had maintained an average deficit of 1.2 percent of G.D.P. More recent studies have indicated that companies in Europe, Japan and China are also running unprecedented surpluses.

Pointer from Mark Thoma.

Keynesians believe in the paradox of thrift. Saving never increases investment. Instead, if any sector of the economy tries to increase saving, the result is to reduce income. From this perspective, any sector that increases its saving is doing harm, and often Keynesians will go so far as to attribute sinister motives. This means that when the balance of savings shifts, the Keynesians attribute sinister motives to the savers. Keynesians are inclined to blame savers for changes in identities.

Let us walk through some accounting identities involving saving.

1. National saving = trade surplus

This, like all accounting identities, is true always, by definition. It is true whether or not saving is a good thing. It is true whether the economy is strong or weak.

The principle of blaming the savers would tell you that countries running trade surpluses have sinister motives. Hence, Paul Krugman's view of China and Germany.

Next, take the trade surplus as given. For any given level of national saving, we have:

2. Net private saving = government deficit

Net private saving is private saving minus private investment. The principle of blaming the savers would tell you that the private sector is behaving badly when its saving is high. The government only needs to run a deficit because the private sector is being stingy with spending.

Next, take both the trade surplus and the government deficit as given. For any given level of net private saving, we have:

3. Net corporate saving = net household investment

Net corporate saving is retained earnings minus corporate investment. Net household investment is purchases of houses and consumer durables minus household saving. Once again, the principle of blaming the savers would tell you that when net corporate saving rises, it is because corporations have sinister motives. Hence, Smith and Parentau write,


The reason for all this saving in the United States is that public companies have become obsessed with quarterly earnings.

The thesis that savers are driving these identities could be correct. However, one might tell the story differently. That is, one could choose to blame the spenders. It could be that the U.S. trade deficit is caused by the lack of U.S. national saving, rather than excessive saving by China and Germany. It could be that the high government deficit causes savings to rise elsewhere (including in China and Germany, as well as private sector saving in the United States). It could be that massive spending by households during the housing bubble caused savings elsewhere to rise (including in China and Germany, as well as the corporate sector in the United States). Then when massive spending by government kicked in during the last two years, savings elsewhere had to rise, including the corporate sector.

I do not like these latter interpretations any better. In general, I think it is really bad economics to tell stories about accounting identities that blame one side of the identity or the other. Instead, economists should trace movements in saving and investment back to exogenous factors that affect relative prices, including risk premiums. Unfortunately, when it comes to looking at savings identities, a sort of Gresham's Law seems to apply in the media. Bad economics drives out good.


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CATEGORIES: Macroeconomics



COMMENTS (7 to date)
Boonton writes:

Arnold,

Keynesians believe in the paradox of thrift. Saving never increases investment.

Actually I believe a more nuanced view of Keynesians is that savings rates increase investments. Given two different economies, the one with the high propensity to save (or lower propsensity to consume) will achieve more investment in the long term and barring innovation will reach a steady state faster. In the short term, the amount of savings is determined by income. Hence attempting to increase savings through policies that decrease income will be self defeating on some level.

But given two economies that are at full employment over the long term (through proper policies), the one with the higher savings rate will be better off.

What I don't get by excusing China in your post is that China is very blatently managing its economy and currency. They have adopted a policy of rapid and sustained growth through exports as part of a command economy's strategy to provide jobs and industrialization to its farming sectors. This strategy is implemented by frustrating normal market forces that would normally increase consumption by workers in its export industries. As you point out in your first identity:

National saving = trade surplus

A country that generates a huge trade surplus relative to the rest of the world MUST also generate lower savings in the rest of the world. It would seem then that a policy that tries to simuluate the natural market rise in China's currency (like Krugman's idea of a flat 10% tax on Chinese imports) would necessarily reduce China's savings and increase the US's. Hence the odd bind China is in where they need the US policies that they bemoan (low savings rates, high deficits).

ThomasL writes:

If the statement, "[P]ublic companies have become obsessed with quarterly earnings," is correct, I wonder if it might indicate a longer run trend toward uncertainty than ~2007 onward.

That is, it may as easily mean businesses have become chary of long-term investment as that they have become obsessed with short-term earnings.

Darrell Balmer writes:

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Jacob writes:

My understanding is that the paradox of thrift is important primarily during a recession or a weak recovery. Keynes wrote that during a boom, governments should be saving and monetary policy should be tight.

Can you point me to some reference supporting your interpretation of the paradox of thrift? In the meantime I'm going to check Keynes' General Theory...

Lord writes:

For Keynes, savings was not normally a problem as the change in interest rate would favor or stem it as necessary. It was actually change in investment appetite and animal spirits that caused large disruptions, especially as interest rates are not capable of becoming negative. Deflation is a real risk under such circumstances. It is when savings has no investment outlet that leads to falling output to bring savings back into balance with investment and why public investment could be so productive then.

MMJ writes:

re profits --- they completely overlook the source of the recent rise in corporate profits, i.e. cost-cutting rather than top-line growth. furthermore, the fact that profits are high now says nothing about the outlook; profits were high in 2007, shortly before a terrible recession.

Yancey Ward writes:
A country that generates a huge trade surplus relative to the rest of the world MUST also generate lower savings in the rest of the world. It would seem then that a policy that tries to simuluate the natural market rise in China's currency (like Krugman's idea of a flat 10% tax on Chinese imports) would necessarily reduce China's savings and increase the US's. Hence the odd bind China is in where they need the US policies that they bemoan (low savings rates, high deficits).

You are doing exactly what Kling warns against.

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