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Domestic Savings in Developing Countries

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1972
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Jean van der Mensbrugghe

From various studies made by the Department of Economic and Social Affairs of the United Nations, it appears that in developing countries as a whole, the ratio of gross domestic savings to gross domestic product (GDP) increased from about 12 per cent in 1955 to about 15 per cent in 1968. The report of the Committee on Development Planning, of which Professor Tin-bergen was Chairman, issued early in 1970, recommended that this ratio be raised to about 20 per cent by the end of the Second Development Decade (i.e., by 1980). Such an increase in the savings ratio was deemed a necessary, but not sufficient, condition if developing countries were to achieve, in this Decade, an average annual rate of-expansion in the range of 6-7 per cent in total GDP and of 3.5-4.5 per cent in per capita GDP.

Any marked increase in the savings ratio requires not only deliberate government policies but also positive action by households and business enterprises.

Savings by Households

Savings by households are dependent on a great variety of factors, a number of which can be influenced by government policies. First among the factors that may be thus influenced is the rate of growth of disposable income (i.e., income after payment of personal taxes). In developing countries, however, savings are inevitably small compared with those of developed countries, and they will increase only with the growth of income. The government might decide to tax the whole of the increase in income by households, but such a decision would depend, among other things, on the policy pursued in the matter of public savings (see below).

The age distribution of population is another factor. The dependency rate measures the ratio of children, invalids, and retired persons to the labor force. The higher the dependency rates the lower the savings by households. High dependency rates will also tend to depress government savings because they push up expenditures for education, health, etc. They will also push up the volume of investment needed to raise the capital-labor ratio. The dependency rate is high in most developing countries, and a number of economists have expressed pessimism concerning the possibility of achieving substantial increases in the savings rates of underdeveloped countries unless birth rates are reduced.

Distribution of Income

The distribution of income is also a factor. In developing countries, the majority of households may hoard some banknotes or seeds to be used in case of emergency, but they are too poor to save in other forms. Furthermore, empirical studies have shown that in both developed and underdeveloped countries the marginal propensity to save out of income from employment was much lower than that for income from other sources. The main reason to be adduced for this phenomenon is that usually employees receive lower incomes than other social groups.

The government can provide investment opportunities that suit the motivations of households. Households generally save for one of three purposes: to purchase housing or durable consumption goods such as a bicycle or sewing machine in poorer countries or a car or electrical appliances in richer countries; to insure members of the household against death, sickness, or accident, or to provide for old age; or to purchase assets which will yield an income in the future.

In order to satisfy the first two kinds of aim, households may hoard banknotes; they may also deposit cash on current or on savings accounts with commercial banks or on savings accounts with post office savings banks, credit unions, building societies, and the like. Experience shows that the amount of savings depends partly on how widespread these facilities are; if they are pushed right under the individual’s nose, to the extent of having street savings groups, or factory groups, or even deduction from earnings at source, people save more than if the nearest savings institution is some distance away.

Savings institutions may, with the savings they collect, finance the construction of homes; and households, when they repay the mortgages they have received to purchase their own lodgings, are building up equity in their own house.

Insurance Savings

Households may also insure against death or provide against old age by paying premiums to life insurance companies or by making contributions to retirement funds. These payments are effected regularly, and this form of saving by households is traditionally used by life insurance companies or retirement funds—the bulk of which are referred to as institutional investors—to finance long-term investments. In most developing countries this form of saving is relatively uncommon, but it is growing with economic development.

Households wishing to purchase income-yielding assets may also make deposits on savings accounts. They may purchase bonds; this form of investment was relatively widespread in Europe during the nineteenth century, but developments since World War I have given rise to what Keynes has called the “euthanasia of rentiers.” Their wealth, which consisted largely of bonds, was considerably reduced in value by the prevailing inflation, and sometimes, as in the runaway inflation which took place in Germany in 1923, was reduced to zero. Furthermore, over most of the last 50 years, the income that rentiers could draw from bonds was affected by low interest rates, as in the 1930s and the 1940s, or again by inflation. As a result, in developed as well as in developing countries, bonds have become a much less favored form of financial investment than they were in the nineteenth century.

Households may, furthermore, pool their savings in companies with limited liability created for a specific purpose. The introduction of such companies in commercial law in the nineteenth century is generally considered to have played a significant role in the development of savings in Europe. It is also important that households be given the opportunity to withdraw their shares in companies in which they have invested and that there should thus be a stock exchange in which shares could easily be traded. A number of developing countries have, or plan to establish in the near future, stock exchanges.

Savings and Inflation

The provision of opportunity, then—the opening or widening of channels through which savings can flow— is one means by which governments can encourage savings. It can also influence the return on investment, actual and expected. The return may take the form of interest earned on investment and/or of capital gains. It is well known that inflation may reduce, and even annihilate, the real interest rates on bonds, bills, and savings deposits. To overcome these consequences of inflation and as part of a stabilization program, some countries, e.g., the Republic of China and Korea, have increased the nominal interest rates on savings deposits so as to maintain for potential savers a positive rate of return in real terms. Such an increase did result in a marked increase in savings deposits.1 In some countries, also, some type of savings, mainly bonds, have been indexed. Through indexing, often called value linking, the nominal value of a bond, or the interest to be paid on that bond, or both, are linked to the cost of living index, or any other price index, or, even, in some cases, to a production index. For instance, bonds issued by public enterprises may be indexed on the production of these enterprises, e.g., electric power or gas.2

Governments may also increase the rate of return by exempting from direct taxation some types of savings, or by subsidizing the interest rate paid on certain categories of savings.

Business Savings

Business savings consist of undistributed profits, that is to say, of that part of the income available to the entrepreneurs that remains in the enterprise. Economic historians agree that business savings were the main source of savings in Great Britain during the so-called Industrial Revolution. In a recent report, the Department of Economic and Social Affairs of the United Nations observed: “It is probable—though this cannot be documented—that in most developing countries the bulk of the private saving is generated in the business sector.” 3

The development of business savings needs as a prerequisite the emergence of a new class in society—the profit-making entrepreneurs—which is more thrifty than all the other classes (the landlords, the wage earners, the peasants, the salaried middle classes), whose share of the national income increases relative to that of all others. In private capitalism, the entrepreneurs reinvest the bulk of their profits, while in socialist economies the profits are concealed in the tax system and are reinvested on public account.

In an economy with private enterprises, the government may influence the development of business savings in various ways. It may exempt business profits from direct taxation for a number of years starting with the establishment of an enterprise. It may levy taxes at different rates on distributed and undistributed profits. The government regulations about the tax treatment of inventory valuation and of depreciation allowances also have a direct impact on business savings.

Government Savings

Government savings do not consist of a possible surplus of the current (or ordinary) budget which would then be used to finance expenditures in the equipment (or extraordinary) budget; they correspond to public investment financed by the government’s current income (mainly tax receipts and profits of public enterprises). In developing countries, government savings are especially needed to finance the building of transport facilities and the establishment of public utilities that are a prerequisite to economic development. In a number of countries, they are also needed to compensate for the lack or inadequacy of private investment in the business sector.

To increase public savings, governments have to take complementary action. They have to ensure that current expenditure does not rise unduly fast and that an expanding margin of current revenue over current expenditure should be available to finance public investment. In this connection, it should be noted that investment in public works and utilities generally results in a marked increase in current expenditure (upkeep of transport facilities and running costs of education and health facilities). Strict control of public expenditure will help in restraining the rise in government expenditure, but this measure needs to be supplemented by measures in the tax field.

Governments should design tax systems and pursue tax policies that would result in a faster rate of increase in tax revenue than in the gross national product of the country. This might be done through the imposition of new taxes, through increases in existing tax rates, and through measures against tax evasion. The tax system should be designed in such a way as to tap as far as possible funds that otherwise would have been used for consumption; transferring savings from the private to the public sector should be accomplished by borrowing rather than by taxation.

Measures should be taken to improve the net earnings of public enterprises. This would, among other things, require that these enterprises be managed efficiently and be allowed to charge prices that would enable them to earn profits which could then be invested, in accordance with government policies, either in the profit-making enterprise or elsewhere. Save in exceptional circumstances, public enterprises should not be permitted to incur losses that would have to be met out of public funds.

Conclusion

In developing countries, an increase in savings will require a combination of government and private action. As mentioned by Professor Ragnar Nurkse:4 “Each country must work out its own mixture in accordance with its own particular needs and opportunities. There can be no standard recipe of universal applicability.”

See “Interest Rate Policies in Developing Countries,” by Anand G. Chandavarkar, Finance and Development, March 1970.

See “Countering Inflation: The Role of Value Linking,” by Sanjaya Lall, Finance and Development, June 1969.

World Economic Survey, 1967, Part I, “The Problems and Policies of Economic Development: An Appraisal of Recent Experience” (New York, 1968), p. 87.

Problems of Capital Formation in Underdeveloped Countries (New York, Oxford University Press, 1947), p. 151.

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