National savings are the sum of private sector savings and public sector savings. It represents the total loanable funds provided by the domestic economy. This term is also synonymous with gross national savings or domestic savings.
National saving is an indicator of the health of a country’s investment. A high level of savings means more sources of loanable funds in the country, indicating the deepening of the advanced financial markets.
How to calculate national savings
National savings come from two sources the public sector and the private sector. The private sector consists of household savings and business savings.
National savings = Private savings + Public savings
Public savings come from the government sector. It is positive when tax revenue exceeds government spending. Or, when the government runs a fiscal surplus. And when tax revenues are lower than expenditures, the public sector experiences dissaving.
Private savings formula
Private savings are the amount of income left after paying taxes and consumption. The formula for private savings is:
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Sp = I + (G – T) + (X – M) …. (equation 1)
In some textbooks, private savings are also written with the equation:
Sp = Y – T – C … (equation 2)
Where:
- Y = Aggregate income, represented by GDP
- I = Private investment
- G = Government expenditure
- T = Tax revenue
- X = Export
- M = Import
Equation 2 shows private savings are the remaining aggregate income after deducting taxes and consumption. Y-T is national disposable income, i.e., the aggregate income left after deducting tax payment.
Why I use two equations? Are both are same? And, let’s prove it.
In the income approach, the GDP formula is the same as Y = C + I + G + (X – M). If you substitute Y into equation 2, you will get:
Sp = Y – T – C = C + I + G + (X – M) – T – C = I + (G – T) + (X – M)
Public savings formula
Public savings are the amount of tax revenue left after the government finances all its expenditures. Mathematically, we can write it as follows:
Sg = T – G
If the government runs a fiscal surplus, it means the government is saving. At that time, tax revenue (T) is higher than expenditure (G).
Conversely, when running a fiscal deficit, there is dissaving in the public sector. Tax revenue is lower than government spending. Deficit reduces the total supply of loanable funds.
National saving formula
As a definition, national saving is the sum of private savings and public savings.
Sn = Sp + Sg = I + (G – T) + (X – M) + T – G = I + (X – M)
From the equation above, you can see, if a country adopts a closed economy (there is no international trade), the value (X – M) is equal to zero. As a result, national savings equal investment.
Furthermore, national savings are useful for:
- Financing domestic investment
- Lend foreigners (net exports)
If the government runs a fiscal deficit (public dissaving), one of the conditions below must occur:
- Private savings must increase
- Domestic investment fall
- Net exports fall
How to calculate the national savings rate
National saving rate is the proportion of domestic savings to aggregate income. Because GDP represents aggregate income, you can calculate it by dividing national savings by GDP.
National saving rate = National savings / GDP
This indicator is important to see the domestic financial capacity to grow the economy. As discussed earlier, national savings are a source of funding for domestic investment.
If the saving rate is low, domestic investment relies on foreign capital inflows to grow the economy. Conversely, higher saving rates help finance investment and increase the productive capacity of the economy.
Why must savings equal investment
National saving is one of the factors driving economic growth in the long run. It represents a domestic supply for loanable funds for investment to increase the production capacity of an economy in the long run.
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In a macroeconomic, saving equals investment in a closed economy. Savings represent the supply side of domestic loanable funds. Meanwhile, the investment represents the demand side. Supply-demand for loanable funds meets in the financial markets.
To understand, I will take a simple example. Say you want to save Rp100 and invest it in corporate bonds. At the same time, a company intends to issue corporate bonds to finance investment in capital goods.
Because you are interested in the yield, you buy all the company’s bonds. As a result, money flows from you to the company. Your savings will be the same as company investment.
But, remember, it only applies to the economy in the aggregate. It does not always apply to every household or company.
Also, savings are not the same as investments if the economy is open. Savings might flow out to the international financial market rather than the domestic market.
How does government spending affect national savings
If the government runs a fiscal deficit, public savings are negative. National savings decrease, thereby reducing the supply of loanable funds in the economy.
Because interest rates represent prices for borrowing money, a decrease in the supply of funds will drive up interest rates in the economy.
Higher interest rates make borrowing costs more expensive. That affects the willingness of the private sector to borrow. An increase in interest rates causes fewer families to buy new homes and fewer companies purchase new capital equipment.
As a result, the fiscal deficit causes a decrease in business investment and household consumption. Economists call this phenomenon the “crowding out effect.” It can reduce the rate of economic growth if household consumption and business investment are more significant than government spending.
How national savings affect the trade balance
Before discussing it again, let’s take the national savings formula above:
Sn = I + (X – M)
If national saving exceeds domestic investment (Sn> I), there is an excess supply of loanable funds. Domestic money will flow abroad, for example, by investing in other countries’ sovereign bonds. Net exports will increase.
Conversely, when national saving is lower than domestic investment (Sn <I), net exports will decrease. The domestic economy must borrow from abroad to finance investment (through capital inflow).
When a country experiences a trade deficit (M > X), it can occur because domestic savings are inadequate to finance domestic investment (Sn < I). Or, it happened because of the government’s fiscal deficit.
For example, if the national saving is IDR1,000 and domestic investment is IDR2,000, then net exports will be equal to IDR1,000 (trade deficit).
Say, private sector savings are IDR3,000 and domestic investment is IDR600. Hence, the government budget deficit will equals:
- Sp + Sg = I + (X – M)
- IDR3,000 + Sg = IDR2,000 – IDR1,000
- Sg = – IDR2,000
