Diagnostics of savings: India vs Pakistan

January 19, 2004

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Savings provide the most important economic link between the past, present and future of a country. The stock of savings of a nation sets a limit on the level of its gross investment and its growth rate.

As a corollary, a low rate of savings if maintained over a longer period of time, entraps an economy in a vicious circle of low investment, low growth, low productivity and low real per capita income and so on.A higher rate of savings is therefore a prerequisite for a country getting out of low-saving-low-growth equilibrium.

The national savings rates of India and Pakistan have shown a wide differential both historically and at a given point of time. India's current national savings rate is about 24 percent of GDP, significantly higher than the saving rate of Pakistan which is estimated at 13 percent.

Historically, the saving rates of both India and Pakistan have shown a rising trend, but the increase in India's saving rate has been significantly higher than the increase in Pakistan's saving rate with the result that the gap between the two saving rates has widened over years.

A meaningful analysis of saving behaviour is a complex exercise, because the determinants of savings behaviour are myriad and cut across the entire spectrum of factors related to economic, social, political and cultural behaviour. Even within the profile of determinants which are purely economic in nature, one finds a wider diversity of factors which critically influence the saving behaviour of a particular society. This aspect has been highlighted by Profssor Kotlikoff of Boston University in his numerous writings.

"The study of savings", according to Professor Kotlikoff "brings together analysis of consumption choice, labour supply, demographics, economic growth and government policy". He then suggests that the use of partial equilibrium tools in analysing saving behaviours may not be of great help, rather it would require the use of a dynamic general equilibrium framework to dissect the impact of various factors on saving structure and propensities of different communities.

He emphasizes: "While it would be convenient if each of these influences on savings could be understood one at a time and in partial equilibrium, such is typically not the case. On the contrary, since savings depends, in part, on a large array of interrelated economic choices and since these choices are intertemporal in nature, understanding savings requires a dynamic general equilibrium framework". (What Determines Savings? by Lawrence J. Kotlikoff, MIT Press, Boston 1989).

The aggregate savings of a country have three components namely private, corporate and the public sector savings. Each of these components has its own specific determinants and that further adds to the complexity of analysis.

In different countries, the three components assume different weights, implying that aggregative techniques for analysing saving patterns of societies at different stages of economic development may not provide sufficient insight about the saving behaviour across countries.

The weight of factors which are critical in determining the saving rate in a subsistence economy where a majority of population lives below poverty line, may carry a small weight in explaining the saving behaviour of societies which in the Rostowian paradigm belong to the "drive to maturity' or to the "mass consumption" stage.

The mature, rich and industrialized societies with near full employment level of income are likely to follow the life-cycle pattern of consumption and savings as suggested by Modigliani, while the absolute income path suggested by J.M Keynes may offer a better explanatory framework for savings in the developing countries.

Another factor adding to the complexity of saving behaviour is the relationship between private sector and public sector savings. Whether private sector saving is crowded in, crowded out or remains constant by changes in the public sector savings is an important aspect of aggregate saving behaviour of a country.

In recent years, numerous models have been developed to analyse the linkages between fiscal deficit (a broad measure of public sector dissaving) and the private sector savings. An attempt has been made through these models to study whether public sector dissavings promote and induce additional private sector savings and thus leave the overall savings (national) rate unchanged or not.

These studies use the well-known Ricardian Equivalence Approach, which has its roots in David Ricardo's classical "The Principles of Political Economy and Taxation" published in 1817. postulating that under certain circumstances, the mode of financing fiscal deficits is not very relevant for budgetary management and that public dissavings can be compensated by higher private sector savings, leaving the national saving unaffected. Considering its specific orientation and outcomes, the theme of Ricardian Equivalence needs a separate treatment.

An exercise has been undertaken by the author to quantify the principal and the most important factors which help explain the saving behaviour of the South Asian countries as well as the differential of savings rates between India and Pakistan. This exercise is based on some of the methodologies used in author's Ph.D. dissertation submitted to Boston University in 1991 entitled "Savings, Consumption and Ricardian Equivalence: A Macroeconometric Analysis of Pakistan 1960-88".

Under this methodology, a regression model of national savings incorporating the major and the critical macroeconomic variables was specified and estimated using the cross country and time-series data for Pakistan, India and Sri Lanka covering the 29 years period 1960-88.

The estimation of the model was instrumental in identifying the sign, magnitude and statistical significance of the co-efficients of the macro-variables which were drawn from diverse blocks of the economy such as growth-investment block, the demographic, monetary and the external blocks.

The detailed and indepth analysis of this model facilitated in diagnosing the differential between saving rate of India with an average value of 18.8 percent for the period 1960-88 and saving rate of Pakistan which was 10.9 percent for the same period. The difference between the two rates of the magnitude of 7.9 percent of GNP was certainly very large. Details are given in Table 1.

Table 1: India and Pakistan comparative data
(The average values for 1960-88)
Economic variables India Pakistan Difference
(1) (2) (3) (4)=(2)-(3)
i) National saving rate (%) 18.8 10.9 7.9
ii) Growth rate in real GNP (%) 3.9 6.3 -2.4
iii) Population growth annual rates (%) 2.3 3.0 -0.7
iv) Government expediter on
education/GNP ratio(%)
2.8 1.6 1.2
v) Government expenditure on
defence/GNP ratio (%)
2.8 5.8 -3.09
vi) Exports/GNP ratio (%) 4.0 6.4 -2.4
vii) Import/GNP Ratio (%) 6.3 13.2 -6.9
viii) Gross external aid/GNP ratio (%) 1.3 4.4 -33.1
ix) Tax/GNP Ratio (%) 12.6 7.6 -0.2
x) Inflation Rate (%) 7.4 7.6 -.02
xi) Real Interest Rates (%) -0.696 -0.013 -0.683

Before presenting the results of the regression model, it is imperative to note that variables such as the level of per capita income, exports as ratio of GNP, external aid inflows, real interest rates and government expenditure on education as a ratio of GNP have been found to be positively correlated with the national saving rates and variables such as population growth rate, government spending on defence, and imports have been found to be negatively correlated with the national savings rates.

Based on the positive and negative determinants of savings as succinctly discussed above, the model has helped in identifying the four macroeconomic variables which consistently increased the saving rate of India viz-a-viz Pakistan. These four variables which were labeled as 'unfavourable' for Pakistan were population growth rate, imports, government expenditure on defence and government expenditure on education.

The population growth rate being negatively correlated with national saving rate, lowered Pakistan's saving rate as compared to that of India, because on the average population growth rate in Pakistan for the period 1960-88 was 3.0 percent per annum against India's 2.3 percent.

Similarly the import ratio for Pakistan being 13.2 percent against India's 6.3 percent, depressed saving rate disproportionately for Pakistan, and the same was the case of defence spending which was 5.8 percent of GNP for Pakistan and only 2.8 percent for India. The expenditure on education, though positively correlated with saving was the fourth 'unfavourable' factor because Pakistan's average spending on education at 1.6 percent of GNP was lower than 2.8 percent for India.

The combined contribution of these four 'unfavourable' factors to the differential of 7.9 percent in the saving rate between India and Pakistan was 7.0 percent with a weight of 88.6 percent.

Against the 'unfavourable' factors briefly discussed above, another set of four factors was identified which raised the saving rate in favour of Pakistan viz-a-viz India namely the level of per capita income, export/GNP ratio (6.4 percent for Pakistan against India's 4.0 percent), external resource inflows (4.4 percent of GNP for Pakistan against India's 1.3 percent) and average real interest rates (-1.3 percent for Pakistan against -6.9 percent for India). These four 'favourable' factors helped in reducing the saving rate differential between India and Pakistan, by 2.2 percent with a weight of 27.8 percent in the saving rate differential between the two countries. Table 2 gives the details.

The unfavourable factors having explained 88.6 percent of the saving difference between Pakistan and India, the favourable factors i.e. the factors which raised the saving ratio of Pakistan compared to India had the combined effect of 27.8 percent. The net effect of the unfavourable factors came to be 60.8 percent. This implies that there is a residual of 39.2 percent in the saving differential in the saving rates of India and Pakistan which has not been explained by the economic variables incorporated in the model.

How to explain this large residual in the saving behaviour of India and Pakistan? Broadly speaking, this unexplained residual reflects the impact of non-economic factors which cannot be captured in the regression models, but have immense influence in moulding the saving behaviour of different societies.

The contemporary theory of saving behaviour suggests that cultural and sociological factors play a critical role in determining the saving-consumption decisions of communities over time. In this regard, the observations of Professor Irvin Friend are as much relevant for explaining the national saving as the private saving of the society.

According to Friend, "The apparent paucity of non-coercive economic measures which could be taken by the government to increase household or private savings may seem strange in view of the extremely large observed differences in the underlying saving-income ratios for different countries. Although these differences have not been satisfactorily explained in the literature, it is my judgement that to a major extent they represent cultural differences or differences in tastes (perhaps like those reflected in the Puritan ethic).

As a consequence, it may be possible to increase private saving more effectively through non-economic means than through economic policies". (Irvin Friend, The Policy Options for Stimulating National Saving in F. Gerad Adams and Susan Watcher, Saving and Capital Formation, Lexington DC, Heath (1986).

The cultural differences in the saving and consumption behaviour within India and Pakistan can be clearly seen in the manner in which Pakistanis spend on marriages, social functions and religious ceremonies. Basically the Indian culture is pro-saving, while Pakistani culture is pro-consumption.

The critical finding of this exercise is that given the cultural differences, demographic factors and the factors associated with human resource development explain more than 50 percent of the difference between the savings rate of India and Pakistan.

This finding corroborates with some of the earlier studies which have assigned paramount importance to these factors in explaining the process of economic growth, changes in productivity and rates of capital formation in India and Pakistan. The role of public spending on defence and the import ratios also explain a significant portion of the saving differential between the two countries.

As a policy package, for raising the saving rate, Pakistan must increase significantly its expenditure on education, reduce spending on defence, reduce the existing population growth to about 1.00 per annum and raise the growth rate of real GDP. As regards the cultural aspects, it if for the sociologists to suggest as how to transform a pro-consumption into a pro-saving culture.

(The views expressed here are personal to the author and do not represent the Government of Pakistan or the Planning Commission where he is employed as Chief/Project Director (Macro-modeling).