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Economic Growth…Between Consumption and Savings (18/01/2018)
Union of Arab Banks - Research Department

The World Bank and the International Monetary Fund both forecast an increase in global economic growth in 2018, driven by an upswing in economic activity in line with the recovery in global consumption, investment, manufacturing, trade, and commodity prices. According to the IMF, global growth is expected to reach 3.7% in 2018, after hitting 3.2% in 2016, its lowest level since the 2008 financial crisis.

Savings play an important role in the economy, as the saving rate is the main determinant of overall investment which is a crucial component of economic growth and development. On the other hand, excessive saving at the expense of consumption may prove detrimental to the economy as it leads to a decrease in aggregate demand on goods and services, and a subsequent fall in company sales revenues and profits, ultimately creating a negative multiplier effect of less job creation or employment opportunities and lower income. This vicious cycle results in a further decrease in consumer spending and aggregate demand, eventually leading to an economic slump. In economic theory, this is dubbed ‘the Paradox of Thrift’ popularized by British economist John Maynard Keynes. It argues that while thrift may be an individual virtue, it hurts society at large when people save too much and spend too little. The basic concept is that if people save more in a recession, this will reduce consumption and thus aggregate demand will fall, impeding economic growth. Consequently, it becomes the government’s responsibility to reestablish consumer confidence and stimulate growth via expansionary monetary policies and quantitave easing programs. By increasing money supply in the economy and lowering interest rates, the goal is to stimulate borrowing and consumer spending in hopes of raising aggregate demand.

The Japanese case is the best example on how a high savings rate can have a negative impact on economic growth. Gross savings reached 27% of GDP in 2016 (compared to 17% in the United States), amid low consumer spending as the Japanese save around 35% of their annual income.
The Japanese culture of saving as well as Japan’s rectangular or top-heavy population pyramid due to its aging society are main reasons behind its high savings rate, as the large number of elderly floods the market with savings (the supply of credit), while fewer younger workers limits consumption spending and demand for credit. This phenomenon, associated with weak consumption expenditure, reinforced Japan’s status as an export-driven economy with great dependence on its competitive exports and trade surpluses for growth.
Japan, the third largest economy in the world by nominal GDP, still faces a number of geopolitical, demographic, and economic challenges, as export revenues proved insufficient to counterbalance the reduction in aggregate demand and stimulate economic growth.
Despite pursuing massive quantitave easing for over a decade, to the extent of launching a negative interest rate policy – charging fees on commercial banks’ deposits in their accounts in the central bank – to facilitate more lending to consumers and businesses, Bank of Japan (BOJ) failed to improve the fundamentals of the stagnant economy by failing to boost consumer spending and prices.
Moreover, Japan is the most indebted country in the world, as measured by general government gross debt as a percent of GDP. In 2017, the Japanese debt-to-GDP ratio stood at 240.3% (compared to 108.1% in the United States), making it the world's sole debtor above the 200% threshold. According to Bloomberg, while the government is heavily indebted, the wealth of Japan’s households climbed to a record 1,800 trillion yen ($16 trillion) in savings, stocks and other financial assets at the end of 2016, 52% of which was in cash and deposits.
Hence, frail consumer spending, which accounts for 60% of GDP, failed to help Japan in its 25 yearlong battle with deflationary pressures and contributed to a low inflation rate of 0.5% in 2017, far from the BOJ’s 2% target, as firms remain wary of driving away cost-sensitive consumers with price hikes.
Furthermore, while the Bank of Japan’s monetary policy has been highly accommodative for decades (characterized by low nominal interest rates and an elevated central bank balance sheet), it remained insufficient to revive growth due to low consumption spending, excessive saving, and insufficient investment, as the average GDP growth rate remained low at 1.2% over the past 5 years, and is expected to remain below 1% in 2018, according to the IMF. These characteristics are generally regarded in economic literature as a case of a liquidity trap.

The Japanese experience sheds light on the importance of consumer spending and borrowing to boost economic activity and growth. It is indisputable that consumption expenditure is the biggest component of GDP, and the main driver of economic growth in both advanced and emerging economies.
The fastest growing economies today do not rely on savings or trade surpluses, but on strong domestic demand and consumption spending to fuel growth. The American economic model is the best example as the spending and credit culture overpowers the saving culture amid high consumption and borrowing rates. Despite recording a trade deficit of $502.3 billion in 2016, GDP growth in the United States accelerated from 1.5% in 2016 to 2.2% in 2017 and an expected 2.3% in 2018, according to the IMF, supported by strong consumption spending and a high level of consumer confidence which encourages a higher marginal propensity to consume. Consequently, inflation rose from 0.12% in 2015 to 2.1% in 2017, in line with the Fed’s 2% target.

The US federal government has more than $20 trillion in outstanding debt, $5.6 trillion (or 28%) of which as Intragovernmental Holdings. Japanese savings have played an important role, as Japan is the second largest holder of US securities after China, owning $1.2 trillion of US debt as of October 2017.

Unlike Japan, credit-funded or credit-based consumption spending is highly popular in the United States. While financially savvy consumers around the world are trying to curb consumption in order to match expenses with incomes, Americans often use their credit cards to spend their future income and resort to loans to finance their consumption. As credit expands, more money circulates the economy, consumption and investment expand, which in turn stimulates job growth, profits, and income.

However, credit-induced economic booms have proven to be fragile, unsustainable, and sensitive to market fluctuations, for it is only a rise in real income resulting from productive investments that can bring sustainable economic growth.


Restoring credit growth was the main goal of post-financial crisis economic policy; however, rising levels of private debt (household and corporate) have caused the International Monetary Fund and OECD to recently issue a warning to governments that rely on debt-fuelled consumer spending to boost economic growth, telling them they run the risk of another major financial collapse, as the ECB and Fed gradually unwind their quantitative easing (QE) programs.


In conclusion, evidence from the Japanese model shows that excessive saving does not boost economic growth, especially if it is not directed towards productive investment. On the other hand, the US experience following the 2008 financial crisis proved that an economy cannot grow without strong domestic demand and consumer spending, on the condition that consumers possess adequate levels of financial literacy defined by the OECD as the ability to use skills, knowledge, attitude and behavior to effectively manage financial resources and make sound, rational, and calculated financial decisions, ultimately achieving lifelong financial security and well-being. Financial literacy is crucial for achieving a healthy balance between consumption and savings, and is hence an important element of economic growth and financial stability, especially in the era of Fintech, defined by the Financial Stability Board as “technologically enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services”.


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