If we want to keep growing, let's get saving

Successful economies save. The world as a whole is not saving enough. So will the world economy become less successful?

One of the reasons frequently cited for the rapid growth of the East Asian "tigers" has been the willingness of these societies to save a higher proportion of their GDP than the West. Higher savings, it is argued, underpin higher investment and that investment underpins rapid economic growth. By contrast, it is also argued, North America and Western Europe do not save so much and accordingly growth is lower.

There is a great deal in this argument, for the rapid growth of East Asia is certainly associated with the high savings rates. But a couple of caveats have to be attached. One is that these countries have to save more than we do, partly because of their age structure - lots of young people who will need to provide for their retirement - and partly because of the less comprehensive social welfare systems of these countries. The other is that they also have to invest more.

Our economies have a stock of infrastructure - housing, roads, ports, factories, sewers, power stations - built up over many generations, which these economies have now to construct.

So investment is for incremental improvement; we do not have to start from scratch.

Nevertheless, there is a savings problem in North America and Europe. In North America falling savings through the 1980s (see left-hand graph) have resulted in a long-running current account deficit and the transformation of the US from being the world's biggest creditor nation 15 years ago to being the world's biggest debtor nation now.

In Europe, as argued here last week, the combination of an ageing developed world and unfunded state pension liabilities will put great pressure on public finances over the next generation. This pressure is compounded by the present public sector deficits. European governments should not just be struggling (and failing) to meet the Maastricht criterion of a deficit equivalent to 3 per cent of GDP. They ought really to be running a surplus of about the same amount to cover future pension liabilities.

But this sketch, that the East saves and the West spends, is becoming less accurate. A study in The International Bank Credit Analyst, published by the Bank Credit Analyst research group in Montreal, has highlighted two big shifts in the global savings pattern.

One is in Europe. In many European countries personal savings have risen. Though they may elect governments which are profligate, the voters are themselves virtuous. The European Union as a whole has a large current account surplus with the rest of the world, which is another measure of its saving. (Just in case you think we are not pulling our weight, the UK is in surplus to the rest of the world and would be in overall current account surplus were it not for the payments we make to Brussels.)

The other shift is in East Asia. In Japan, national savings are falling. Individuals still save a lot, but the government (see middle graph) has now gone into deficit, with the result that the position in the early 1990s, when Japan was supplying close to three-quarters of the world's savings, is much more balanced.

Furthermore, the rest of East Asia is joining the ranks of the big spenders. Take again the measure of current account deficits rather than individual savings, and the result is shown in the right-hand graph: the steady decline in the overall trade surplus of non-Japan East Asia. Savings are still high but investment has risen to mop up most of those savings. The total deficit for the region would be even greater were it not for the offshore Japanese plants taking advantage of cheaper labour. This deficit is now close in size to the Japanese surplus, so East Asia as a whole is no longer a large net saver.

What does all this imply for international finance and for the world economy?

The bottom line is that the overall pool of private sector savings is shrinking. The US continues to be an importer of capital, but increasingly that capital is coming from Europe instead of from Japan. Asia outside of Japan may well carry on as a capital importer. Expect therefore, over the next few years, for both Europe and Japan to carry on as capital exporters but for the balance to shift from Asia to Europe. But there will be three substantial effects if the overall supply of savings shrinks.

One is on economic growth. Real interest rates ducked into the red during the 1970s - the interest savers received was more than offset by the loss of capital though inflation - but subsequently have been strongly positive. They have, however, tended to come back to about 4 per cent in most countries instead of the 5-7 per cent they were in the first half of the 1980s. (Though here in the UK, with 3 per cent inflation and 8 per cent bond yields, we are stuck at 5 per cent.) The Bank Credit Analyst team now reckon we may be at the bottom of the real interest rate cycle.

If that is right then it will be quite tough maintaining growth through the last years of this century and beyond. High real interest rates do inhibit growth.

The second effect is that savers, mainly individuals, will benefit at the expense of borrowers, mainly governments. Governments accordingly will have to cut their deficits simply because if real interest rates are high, these deficits balloon out of control very quickly. Those governments which are slow to do so will find their currencies weakening.

The third effect is on the value of the world's stock markets. Once it becomes clear that real interest rates are heading upwards, it will be very hard for share markets to retain their present buoyancy. Of course anyone voicing concern over share prices during the last year has to accept that so far they have been wrong: share prices are at - or close to - record levels in every major market bar Japan. But we have not yet had clear evidence of the rise in real interest rates. We have not yet had to confront this reality.

Look at the world economy as a whole - not just the economies of the developed countries - and the last 15 years have been a period of considerable success. There was, of course, very rapid growth in China and most of the rest of East Asia. Towards the end of the period growth picked up in Latin America and in India. And just in the last three years there is evidence of a turnaround in Eastern Europe and, most recently, Russia.

We need, as a world, to carry on saving if we are not to undermine this progress. Ultimately, interest rates will always balance savings and investment. But the higher the savings the higher the level of economic activity at which this balance will take place.

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