Savings and Investment: Some International Perspectives.

• Author: Schmidt, Martin B.
• Position: Statistical Data Included

Martin B. Schmidt [*]

Consistent with neoclassical growth models, recent estimates of the close association between domestic saving and investment rates may allow policy makers the opportunity to alter investment through the introduction of polices that alter domestic savings. However, such an interpretation presumes an endogenous investment response. Equally likely, at least theoretically, is that the close association is maintained by movements in domestic savings. The present paper explicitly examines the endogeneity of domestic saving and investment rates. For a subset of countries, including the United States, the results suggest that saving adjustments make up only a small portion of investment behavior.

1. Introduction

   In recent years it has become common to lament the deterioration of domestic savings rates as one of the main causes of low GDP growth. The relation between the two represents the essence of most neoclassical growth models that suggest that decreased saving reduces domestic growth because of a reduction in investment opportunities. In this case policy prescriptions for increased economic growth are rather obvious: Introduce legislation that is intended to increase domestic saving rates.

   The present paper is specifically interested in the link between a nation's saving and investment rates. Moreover, it is concerned with whether a nation's investment rate plays the suggested passive equilibrating role. To examine the endogenous responses of a nation's saving and investment rates, the paper focuses on recent empirical models that have characterized the long-run relation between domestic saving and investment. [1] The close association between the two suggests that a shock to one variable may produce an adjustment in the other variable. In this case such models hypothesize that policies that are intended to promote domestic saving may produce congruent investment responses. [2] However, such a policy prescription imputes a direction of causality that has not generally been the focus of these earlier studies. It is possible, at least theoretically, that the saving variable plays the equilibrating role.

   To examine the endogenous responses of domestic saving and investment rates, the paper investigates both the long- and short-run properties of a nation's private saving and investment rates by incorporating the Johansen maximum likelihood methodology (MLE) to estimate vector error-correction (VEC) models for several countries. Furthermore, a more general approach is taken to investigating the endogenous saving and investment responses. Whereas short-run movements in the variables may be an outgrowth of deviations from the defined long-run equilibrium, they may also be produced by movements in the associated saving and investment lags. Finally, the paper examines saving and investment variance decompositions. The decompositions incorporate both responses simultaneously and describe the proportion of investment movements that may be ascribed to changes in savings.

   Overall, the results suggest that the response to saving policies would differ dramatically across countries. Specifically, whereas the long-run estimates are similar for all nations, the short-run investment responses are considerably larger for France and Canada than they are for the United States, Japan, and the United Kingdom. Furthermore, the variance decomposition results for the United States and Japan suggest that only roughly 10% of the investment variance may be attributed to shocks in private saving. The United Kingdom produces a slightly larger value of roughly 24%. In contrast, France's value is close to 40% and Canada's is made up of approximately 58%. In the end, the results suggest that for a significant subset of countries the potential benefits of savings polices may be limited.

   The plan of the paper is as follows: Section 2 describes the hypothesized saving-investment relation, the incorporated Johansen MLE methodology, and the associated VEC models. The following section describes the empirical results from analyzing both the long- and short-run behavior of saving and investment. Finally, section 4 provides a brief conclusion.

2. Assessing the Investment Response

   In examining the relation between a nation's saving and investment rate, Feldstein and Horioka (FH) (1980) estimated the following (long-run) economic relation:

   i/[y.sub.t] = [[beta].sub.0] + [[beta].sub.1] s/[y.sub.t] + [[epsilon].sub.t] (1)

   where i represents domestic investment, s represents domestic saving, and y represents gross domestic product. To assess the value of [[beta.sub.1], FH examined data from 16 OECD countries over several subperiods and were unable to reject the hypothesis that [[beta].sub.1] = 1. Although numerous authors have debated the interpretation of Equation 1, the high degree of correlation between the two variables has been extended and replicated over many time periods, many econometric techniques, and across many nations. [3]

   As was mentioned, the close association may afford a nation the ability to alter its investment levels by altering the nation's saving rate. However, this extension a priori assigns a direction of causality that is not part of Equation 1. To characterize the short-run responses that maintain the long-run relation, Feldstein and Bacchetta (FB) (1991) examined the response of a nation's domestic investment rate to the previous year's 'saving-investment' gap:

   [delta][(i/y).sub.t] = [[alpha].sub.0] + [[alpha].sub.1] [[(s/y).sub.t-1] - [(i/y).sub.t-1]] + [[eta].sub.t]. (2)

   FB estimated versions of Equation 2 for 23 OECD countries. Overall, their findings were consistent with a nation's investment rate responding endogenously to the nation's saving-investment gap. In this case, a nation's saving would Granger cause its investment level. [4] Furthermore, FB investigated whether a nation's saving rate held a similar response. The saving response was, however, generally of the wrong sign and often insignificant.

   As is pointed out in Jansen and Schulze (1996), these two approaches are intimately related, so much so that they argue that the estimation of the equations in isolation would constitute an error in specification. Specifically, the FH saving-investment long-run estimation would be misspecified because of (i) the possible 'spurious' nature of the results, and (ii) even if the relation is not spurious, the formulation ignores the dynamic adjustment process that would maintain the long-run relation.

   Although the FB short-run approach is not subject to the spurious concerns of Equation 1 and does attempt to capture the dynamic adjustment through the gap variable, the misspecification lies within the a priori assumption that the long-run relation between domestic saving and investment rates has a coefficient vector of (1.0, -1.0). A more efficient approach would entail allowing the available data to determine the coefficients. In addition, a more general approach to causality would incorporate and examine the responses of all significant lags of the two endogenous variables.

   To correct for many of these specification concerns, Jansen and Schulze (1996) and Jansen (1996) combine the two approaches within the following VEC equation:

   [delta][(i/y).sub.t] = [[delta].sub.0] + [[delta].sub.1][delta][(s/y).sub.t] + [[delta].sub.2][[(s/y).sub.t-1] - [(i/y).sub.t-1]] + [[delta].sub.3] [(s/y).sub.t-1] + [[eta].sub.t] (3)

   where the lagged differenced saving terms are introduced to further capture the short-run dynamic adjustments and the additional lagged saving rate term allows the long-run relation to differ from unity. [5] Within Equation 3, the long-run relation, [[beta].sub.1], would equal (1 - [[[delta].sub.3]/[[delta].sub.2]whereas the short-run responses, [[alpha].sub.1], would equal [[delta].sub.2]. Jansen (1996) estimates versions of Equation 3 for 23 OECD nations. In general, Jansen's results suggest that national saving and investment rates are related, with coefficients (1.0, -1.0). Also, although the size of the shortrun responses differ substantially across nations, most nation investment rates respond endogenously. [6]

   Unfortunately for the majority of the country saving-investment equations, Jansen is unable to estimate values for both [[delta].sub.2] and...