Chapter 4 SAVINGS AND THE CREDIT MARKET

Saving Rates Solow (1956) model states that increasing the saving rate and decreasing the population growth rate increases GDP per capita. If pop. grows faster than the growth in total GDP, then GDP per capita declines. This is because when pop. grows fast, there is less capital per worker. This decreases productivity and output=income per capita.

Saving Rates in the World Highest savings rates are observed in SE Asia. In period China %42, S. Korea %31, Japan %27, Malaysia 44%. SE Asia’s high growth in the post-WW2 is primarily due to capital accumulation. Poorest sub-saharan Africa: ~%10 Indonesia %24, Nigeria %25, (Perkins et al. ch. 10, 2006)

Saving Rates in Turkey TR : period about %20. Before 86, % Half of China: very low, why?

Saving Taxonomy Components of saving: Fig in Perkins et al.

Stylized Facts About Saving Rates We observe the following patterns:(Perkins et al. 2006): 1.Within a particular country at a given time, saving rate tends to increase with household income, 2.Within a particular country over time, saving rates are roughly constant, more so in developed than developing countries, 3.Across countries, saving rate is lower for the poorest countries and higher for middle and higher income countries. Fig.10-1 in Perkins

Theories on Saving Rates Life Cycle Hypothesis of Saving (Modigliani1970)  Agents save when young, and dissave when old. When population is growing, there are more young than the old, so more saving than dissaving. Also, if GDP is growing, young saves more than the old dissaves. Both points: growth rate of total GDP positively affects saving rate.  Demographics: The increase of working pop. increases saving. If below 15 and above 65 (retired) increases, saving declines.  If life expectancy increases, saving increases because agents save for old age.  Existence of a well-established, state-sponsored social security system tends to reduce saving (also reduces pop. growth).

Theories on Saving Rates Modigliani says higher (GDP) growth rate increases saving rate, but the direction of causality is not clear: others claim that a higher saving rate increases the growth rate. Fig in Perkins et al.

Theories on Saving Rates Other theories: Keynesian Absolute Income Hyp.  As aggregate disposable income rises, the national propensity to save increases, propensity to consume declines. The Relative Income Hyp.  Cons. and saving does not only depend on current income but also on previous income and cons. Permanent Income Hyp. (Milton Friedman)

Factors that Determine Saving Rates Two types: “Ability to save” and “Willingness to Save”. Factors of Ability to Save are:  Depends 70% on GDP per capita(Hussein and Thirlwall 1999). If income per capita is small, then basic necessities, food and clothing occupies most of the budget, hence saving is small.  expectations of income growth. If one expects higher income in the future, today’s saving rate might decline.  dependency ratio (DR). DR measures following: on average how many dependents each working person has to support? High income: 0.5, low income: 0.8. In TR, DR is falling and recently it is 0.5. In 1960s, DR was above 0.8. Figure 4.8 in Akin

Factors that Determine Saving Rates Factors of “Willingness to Save”  Real interest rate increases saving up to some level, but after that level, it does not.  The depth of the financial system, diversity of f. instruments and confidence in the system increases saving. Credit volume / GDP

Factors that Determine Saving Rates Education:  Families decrease saving during education of children. One reason is they depend on govt. support and in order to get scholarships, they report smaller savings.

Credit(=Financial) Markets Channels funds from savers to borrowers. Critical for development, starting a business, growing, education, smoothing consumption. Private sector credits / GDP: shows how deep financial system is.  low income: %15, middle income: %40  high income: %110  In TR, %15-20 until 1995, since then %15-25

Problems in Credit Markets Asymmetric Information (AI): The borrower has more info. than the lender about risks of the borrower’s project. AI leads to two problems:  Before the loan contract: Adverse Selection: more risky borrowers tend to apply more for loans.  After the loan contract: Moral Hazard: borrower engages in actions that make it less likely to repay the loan. Lender cannot perfectly monitor borrower’s actions. Borrower could engage in too risky activities and could default.

Problems in Credit Markets To reduce adverse selection and moral hazard problems?  Need to collect credit history information about individuals and firms. If more info. is produced, credit potential increases because confidence increases. If cost of info. collection increases, interest rate and cost of credit increases.(why loan sharks charge high interest?)  Immigration to cities prevent efficient data collection.

Problems in Credit Markets To reduce adverse selection and moral hazard problems?  Reduce underground economy. Firms report smaller income, wages and assets to avoid taxes like insurance premiums, corporate taxes or to avoid paying min. wage. Or they record wealth on relatives or as personal wealth rather than as firm’s capital. But when firms need to borrow, they cannot report their actual wealth as collateral.  To Reduce Moral Hazard: Credits: Life Insurance, guarantor(s), collateral Car Insurance: differing premiums for different risk groups based on age, marital status, children, discounts based on accident-free and ticket-free years.

Credit Markets Loan Sharks: Underground credit system  High info. collection costs  Enforcement highly costly in case of default  Oligopolistic markets, not much competition.  Plus cost of evading taxes  Result of all: very high interest rates.

What Could the Govt. Do? Must bring the budget into balance: Easier said than done. A major impediment in credit markets in developing countries incl. TR is high borrowing requirement of the govt. If govt. demands so much credit, completely consumes banks’ credit supply, drives up interest rates, crowds out private borrowers. If govt. budget is balanced, interest rates decrease, cost of credit decreases

What Could the Govt. Do? A govt. sponsored social security system tends to decrease willingness to save. Plus, it increases govt. budget deficits. Could increase the retirement age in TR is 50(?). Could increase working period or link retirement pay & health services to premiums paid. Could Promote private pension systems.

What Could the Govt. Do? Microcredit systems: Could subsidize credit to middle&low income group. Could require banks to lend to these lower income groups. Possible only if moral hazard problems are solved?

Non-Governmental Institutions Grameen Bank example. Invented by Muhammad Yunus. Started as a bank in Bangladesh. Makes small loans to the poor without requiring collateral. 98% of the borrowers are women. Bank lends to a group of five borrowers. Each borrower is a guarantor to the rest. Uses peer pressure to endure repayment. The system worked successfully and default rate was less than 5%. Loans for production, not consumption activities. Also used in TR. Master thesis by Muharrem Can at Marmara Uni. (

Capital Accumulation in TR Figure 4.6: Capital expenditures/GDP ratio is in %20-25 range in TR. Fell during the crises of 1994 and Private sector credits/GDP (Fig 4.9) is low. Why?  Shallow banking: Banks do not transform deposits into credits (i.e. do “banking”), but only profit from govt. bonds.  Because govt.’s debt burden and borrowing requirements are sky high. High interest rates, crowding out: govt. kicks private borrowers out.

Possible presentation topics In TR and many other countries, social security system is the biggest hole in govt.’s budget : What could be done? Could systems like Gramen bank be applied in TR, or are they already being used? What are obstacles and could you propose a better microcredit system?