How Does Domestic Saving Matter in Economic Growth

Topics: Investment, Capital accumulation, Economic growth Pages: 51 (16568 words) Published: June 21, 2013
When Does Domestic Saving Matter for Economic
Growth?1
Philippe Aghion
Harvard University
Diego Comin
New York University
Peter Howitt
Brown University
August 4, 2006
1We would like to thank the comments and suggestions of Daron Acemoglu, Pol Antras, Tim Besley, Raquel Fernandez, Mark Gertler, Avner Greif, Elhanan Helpman, Greg Mankiw, Joel Mokyr, Fabrizio Perri, John Seater, David Weil, and seminar participants at Harvard, the He- brew University and Stern, and the excellent research assistance of Juan Diego Bonilla and Victor Tsyrennikov.Abstract

Can a country grow faster by saving more? We address this question both theoretically and empirically. In our model, growth results from innovations that allow local sectors to catch up with the frontier technology. In relatively poor countries, catching up with the frontier requires the involvement of a foreign investor, who is familiar with the frontier technology, together with effort on the part of a local bank, who can directly monitor local projects to which the technology must be adapted. In such a country, local saving matters for innovation, and therefore growth, because it allows the domestic bank to cofinance projects and thus to attract foreign investment. But in countries close to the frontier, local firms are familiar with the frontier technology, and therefore do not need to attract foreign investment to undertake an innovation project, so local saving does not matter for growth. In our empirical exploration we show that lagged savings is significantly associated with productivity growth for poor but not for rich countries. This effect operates entirely through TFP rather than through capital accumulation. Further, we show that savings is significantly associated with higher levels of FDI inflows and equipment imports and that the effect that these have on growth is significantlylargerforpoorcountriesthanrich.

Keywords: Savings, growth, technology adoption, TFP, FDI.
JEL codes: E2, O2, O3.1 Introduction
Can a country grow faster by saving more? The relationship between saving and growth plays a central role in the neoclassical growth models of Solow (1956) and Cass (1965), Koopmans (1965) and Ramsey (1928). It also features prominently in the AK models starting with Harrod (1939) and Domar (1946), and then more recently by Frankel (1962) and Romer (1986). All these growth models emphasizing capital accumulation as the source of growth, tell us indeed that higher saving rates should foster growth because higher savings imply higher capital investment. But these are closed economy models, and extending them to the case of small open economies with international capital markets would eliminate the effect of local saving on growth. More recent models emphasizing innovation as the main engine of growth (Romer, 1990; and Aghion and Howitt, 1992), either ignore capital accumulation, in which case there is no role for saving even in a closed economy, or they emphasize the complementarity between capital accumulation and innovation (Howitt and Aghion, 1998), in which case the equilibrium growth rate depends positively upon domestic saving. But even in the latter case the theory does not apply to the case of an open economy with capital mobility.

Thus existing growth theories appear to have little to say about the effect of saving on growth in the global economy, and yet this question is raised recurrently by policy makers, for example when discussing the contrast between the high growth in East Asia and the slow growth in Latin America, two middle-income regions with comparable levels of per capita GDP in the 1960s. This contrast could hardly be explained by differences in property right protection or in financial development. Moreover, most Latin American countries have subscribed to the so-called Washington consensus policies (namely, the idea of combining macroeconomic stability, trade and financial liberalization, and privatization), but so far to little avail. On the...

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