Gift Kasika
The relationship between savings and investments is important in determining and predicting a country’s economic growth potential and the capacity to finance its own investments.
The analysis below aims to investigate the relationship between savings and investments and the directional cause between the two.
The World Bank’s Growth Report always emphasise that a country’s growth potential depends on its ability to finance its investments from its own savings.
Contrary to this, investments generate savings in the modern world, and therefore the directional cause is from investments to savings, pointing that investments are not financed by savings but by other sources notably bank loans.
In this case, investments do not require savings, meaning that the savings of the public does not play a considerable role in the contribution of a country’s economic growth. Credit extension by commercial banks requires additional cash reserves as it’s a statutory requirement of central banks to maintain cash reserves which therefore suggests that the public’s saving deposits contribute to the finance for investments.
However, investments are not entirely financed by external sources, part of the investment funds are from previously realised income as well as saved money which indicates that savings are a source for investments.
Sources of investment funds differ from country to country.
In some countries, investments are financed more by banks whilst in other States, financial systems are not well developed to a larger extent by savings and retained income. Since savings is considered a source of investment funds, it is of significant value to determine the extent to which households, businesses, and government savings end up financing investments and how much of the saved-up funds end up invested.
Households keep their savings essential in three forms; first as ready money such as notes, coins, and bank deposits which are not loaned out. These funds do not form part of funds for investments and therefore do not influence investment spending.
Secondly, as deposits in savings accounts with a bank. These form of savings does not as well contribute to the stock of investment funds; banks are unable to loan these deposits because the deposit holder has the obligation to withdraw their money at any moment.
Lastly, as financial investments with non-bank financial institutions like Sanlam, only funds saved in this form contribute to the stock of investment funds, non-bank financial intermediaries invest mostly in existing stocks, bonds, and other money market instruments that are traded on the secondary financial markets and thereby only increase trade in secondary financial markets.
Only savings channelled for investments on newly issued financial assets traded on the primary markets end up financing real investments which is relatively a small proportion.
Given as such, only a small proportion of household’s savings are used for investments and besides that large corporates do not depend much on issuing financial assets for their investment. Most of their investments are financed internally from realised profits and external sources such as bank loans and issuing of shares, bonds, and bills which are not only bought by households but by banks and other non-bank corporates.
When corporate financial assets are bought by firms, the business sector does not gain because they cancel out. Large corporate finance large part of their investments about 50% from retained profits which indicates that household savings contribute only a subordinate part to their investment needs.
Business savings and retained profits are the main sources for their investment fund. Large corporate finance more than 50% of their investments from their retained profits. Only small and medium enterprises depend on external finances to a greater degree for their investments. Therefore, to improve the investment capabilities of large corporates, a solution would be adopting policies that will improve their profits.
Government savings are used specifically for government objectives and can therefore not be considered as part of external finance for the private sector. Leaving only household savings deposited with non-bank financial institutes and internal corporate sources as the only financial funds investment pool viable alternatives.
Investment is less likely to be held back by insufficient savings for capital accumulation but by a lack of profitable investment opportunities or by the high risks in available investment areas. The concern in a modern money system is the indebtedness of the public against the banking system.
When businesses and households consider themselves as over-indebted, their response is to reduce spending to accumulate free money to service their debts and they will be inclined not to take any more debits which reduces the money stock and causes a slowdown in economic growth.
In time of crises like this, the government can easy the economic slowdown by conducting stabilising actions to stimulate money growth or alternatively the central bank can conduct quantitative easing policies by purchasing more of existing debts from the public to facilitate money growth. Savings is a means of reducing the over-dependence on bank loans which therefore reduces the associated danger and resulting risks of over-indebtedness on the economy.
An economy requires steadily growing bank indebtedness, when the indebtedness is growing slowly or falling, the income grows slowly or falls which compromises the ability of the public to repay back their incurred debt.
A positive correlation between savings and investment does exist to some extent but appears to be insignificant in this modern monetary system. The directional cause between savings and investment is a matter to be debated with no dominant direction.
Under a modern monetary system, economic growth and the level of investment are not constrained by a lack of savings but by the willingness of businesspeople to borrow from the banking sector and the availability of profitable investment opportunities.
* Gift Kasika is a local economist.