Theme 2 & 4: Short answers - savings and growth

A high gross domestic saving rate usually indicates a country's high potential to invest in capital. State two factors that affect the gross savings rate for a country. Explain how a rise in gross savings might not necessarily lead to a rise in a country’s growth rate.

State two factors that affect the gross savings rate for a country

The gross savings rate is total savings by accumulated by domestic households, businesses and government measured as a share of GDP.

Two fundamental factors that determine the gross savings rate are:

1. The level of real GNI per capita measured at PPP - when extreme poverty is widespread, the majority of households cannot afford to save and corporate profits are limited by size of aggregate demand
2. The fiscal position of the government - i.e. whether a government is able to run a fiscal surplus and therefore build up savings in the public sector

Explain how a rise in gross savings might not necessarily lead to a rise in a country’s growth rate

The Harrod-Domar growth model links a rise in gross savings to an increase in the size of the capital stock and a subsequent increase in a nation’s trend growth rate.

In this model: the rate of growth of GDP = Savings ratio / capital output ratio.

But an increase in gross savings does not automatically translate into faster growth:

1. Weaknesses in human capital will limit the gains from an increase in the stock of capital per worker; there might be significant time lags between increased investment and a rise in factor productivity
2. Financial markets in emerging countries may not channel the rise in savings into productive investments, this is especially true for countries with high rates of corruption and less sophisticated equity and bond markets