Indian policy makers should focus on boosting growth so that a boost in savings will follow, says Swaminathan Anklesaria Aiyar
If there is one thing that all finance ministers from Manmohan Singh and Chidambaram to Yashwant Sinha and Madhu Dandavate agree on, it is that we must raise our savings rate to achieve faster GDP growth. They all think it axiomatic that more savings will finance more investment and thus lead to more growth.
Yet many top economists (such as Dani Rodrik of Harvard University) argue that casuality runs in the other direction, that the growth induces higher savings further than the other way round. This, they argue, is why fast growth and high savings normally go together.
If people worry that increases in income may be temporary and hence prudently spend only a small part of the gain (what economists call the permanent-income hypothesis), then clearly fast-rising incomes will produce a spurt in the savings rate too. Again, the lifecycle theory of saving (which won Franco Modigliani a Nobel Prize) argues that people save for old age when they are in the labour force, and then dissave (or save much less) when they retire. Rapid economic growth will raise the national-income share of high-saving workers at the expense of low-savings retirees, and so raise the overall savings rate.
Possibly, causality runs both ways. Perhaps higher growth raises the savings rate, which then raises GDP growth, much then raises savings yet again in a cycle. Still, we need to know which is the stronger force, which is the chicken and which the egg.
If the main driving force is savings, we need to focus on measures to maximise savings (like high taxation to raise government savings), believing growth will follow. This has been the conventional approach of Indian planning. But if growth is the main driving force, we should focus on growth-friendly policies, confident that savings will rise unaided.
Rodrik’s current research looks at spurts in savings and growth in different countries. He defines a savings transition as a spurt of 5 percentage points in the savings rate, and a growth transition as a spurt of more than 2.5 percentage points in GDP growth. He excludes fortuitous booms arising from the discovery of minerals like oil or diamonds.
His conclusion is clear and statistically powerful. Growth transitions are followed by significant, sustained increases in savings. But spurts in saving are often followed by only temporary spurts in growth that are soon reversed. Even where the savings rate remains high, growth sometimes falls.
Rodrik uses statistical tests called Granger causality tests to check cause and effect. He finds strong statistical evidence that high growth causes high saving. This is markedly so in the short run, but also seems true in weaker measure in the long run. On the other hand he finds, in both the short and long run, that a savings spurt has zero or negative effects on growth! Quite contrary to the conventional Indian notion.
Here are some of the country stories that emerge from Rodrik’s data.
- Korea is a classic case of high growth driving up savings with a lag.
Growth galloped upwards after 1960 because of market-friendly policies, but the savings spurt (as defined by Rodrik) occurred much later in 1984. In the early phase, investment was fuelled largely by foreign borrowings.
Later, fast growth itself created domestic savings for investment.
- In both Taiwan and Singapore, fast growth (induced by market-friendly policies) came first and high savings followed later.
- In Mauritius, a temporary sugar boom in the early 1970s caused a temporary savings boom which then fizzled out. Mauritius went bust in 1980, but then followed a classic structural adjustment programme that produced in turn an export-led boom, rapid growth and a spurt in savings.
- Chile went bust in the early 1980s and both growth and savings plummeted. After structural adjustment, Chile became the fastest growing country in Latin America, and subsequently its savings rate became the highest too. This was aided by its pension reform.
- Countries getting large labour remittances from overseas workers (mainly in OPEC countries) experienced booms in savings. Often this did not translate into sustained increases in GDP growth.
The lesson is sobering. Contrary to our traditional planning notions, savings are not the key to growth. Our own history confirms this.
India’s savings and investment rates rose sharply in the first three decades of independence, yet GDP growth remained stuck at the Hindu rate of growth, 3.5 per cent per year. Only subsequently did two factors — the spread of the green revolution and relaxation of the most stringent controls — enable GDP growth to rise, and savings rose too with a lag.
The market-friendly reforms of the 1990s have further accelerated GDP growth, and the savings rate has risen to a record 25 per cent.
Consider Kerala. It has long had India’s best human capital and high financial savings from migrant workers. These high savings did not, however, induce rapid growth in Kerala because of anti-market policies. So Kerala? savings went into shiny new mosques, real estate development, or other Indian states.
All research has its limitations, and so does Rodrik’s. Looking at other research in the subject, I conclude that while growth is indeed the main driving force, savings is a force too, and growth and savings can chase each other upwards in a virtuous cycle. But this will happen only in conditions favourable to investment and growth, conditions which for decades were absent in India and are still absent in Kerala.
Let nobody think that Rodrik is attacking planning. On the contrary, he strongly emphasises how government intervention aided growth in the four east Asian tigers. But such intervention aimed at accelerating growth through policy reform. In India, alas, intervention aimed at raising savings to finance the public sector’s capture of the commanding heights. Rodrik emphasises that public investment does not fully crowd out private investment, so raising public investment can raise overall savings. It played a major role in the Asian miracle. Yet public investment produced poor results in India.
Why? Because in the four tigers, public investment aimed to complement and help private business, not supplant it (as in India). Korea nationalised its banks in 1961, long before India did in 1969. But in Korea bank finance was directed at export-oriented conglomerates, whereas in India banks became milch cows for the government. Investment subsidies in the tigers were targeted at export-oriented companies, and competition in the international market ensured the subsidies were efficiently used.
In India, alas, investment subsidies (also public investment and the whole planning process) aimed at self-sufficiency, so there was no competition to ensure the efficient use of funds. Nehru thought investment was all-important, and efficiency would follow. It did not.
So, the Planning Commission needs to abandon the conventional approach based on increasing savings to finance ever-bigger Plans. Instead it needs to aggressively promote market-friendly reform, and be a thorn in the flesh of ministers and bureaucrats going the other way. Maybe it can even refuse to release Plan funds to a ministry that fails to deliver on reform promises. If Mr Jaswant Singh is serious about converting planning into a policy-based rather than investment-based process, he has just acquired the ideal man to execute the plan: Montek Singh Ahluwalia.