Why does corporate savings hurt national growth?
December 20, 2010 6:21 AM Subscribe
Help me understand this paragraph from The Economist about the Japanese economy.
In the Nov 20th edition of The Economist there is a big section about Japan. One paragraph in the article On the Down Escalator has me scratching my head.
"In recent years Japanese companies have hugely increased their saving rate, which is now close to 10% of GDP…Some argue that this is a hangover of the excessive debt built up during the bubble years. But Mr. Aida says it may reelect caution over the shrinking population, the strong yen and poor economic prospects. One of his scenarios is that in 15 years' time companies will have saved so much that they will have no net debts. That would be very bad for Japan's future growth. To compensate, the government may have to borrow even more."
">full article here
What I don't understand is why the loss of corporate indebtedness would deteriorate Japanese growth prospects. The article states this point so succinctly I am wondering if this isn't some well understood economic principle: no debt = no growth. If that is the case what is the mechanism behind it? If companies don't (or can't) borrow they cannot maximize their potential and ultimately stagnate? But what about the savings mentioned in the first sentence of the article, wouldn't they just re-invest those savings when the right moment came?
I suspect Google doesn't have to borrow a lot of money and it famously sits on a mountain of cash. I don't see that inhibiting their growth. If all the corporations in a country were in the same position would that be bad for the nations growth. Would it even be theoretically possible for all corporations to hoard cash and not borrow?
Any thoughts appreciated
In the Nov 20th edition of The Economist there is a big section about Japan. One paragraph in the article On the Down Escalator has me scratching my head.
"In recent years Japanese companies have hugely increased their saving rate, which is now close to 10% of GDP…Some argue that this is a hangover of the excessive debt built up during the bubble years. But Mr. Aida says it may reelect caution over the shrinking population, the strong yen and poor economic prospects. One of his scenarios is that in 15 years' time companies will have saved so much that they will have no net debts. That would be very bad for Japan's future growth. To compensate, the government may have to borrow even more."
">full article here
What I don't understand is why the loss of corporate indebtedness would deteriorate Japanese growth prospects. The article states this point so succinctly I am wondering if this isn't some well understood economic principle: no debt = no growth. If that is the case what is the mechanism behind it? If companies don't (or can't) borrow they cannot maximize their potential and ultimately stagnate? But what about the savings mentioned in the first sentence of the article, wouldn't they just re-invest those savings when the right moment came?
I suspect Google doesn't have to borrow a lot of money and it famously sits on a mountain of cash. I don't see that inhibiting their growth. If all the corporations in a country were in the same position would that be bad for the nations growth. Would it even be theoretically possible for all corporations to hoard cash and not borrow?
Any thoughts appreciated
Statements like this are predicated on macroeconomics. Google's behavior is related to microeconomics. What may be economically rational for Google to do, may not be better for the economy as a whole.
The backbone of explaining this is the identity for GDP
http://en.wikipedia.org/wiki/Gross_domestic_product = c + I +g +(x-m)
I= investment
g= government spending
x-m = net exports.
c = Consumption
c= Autonomous Consumption (money that gets spent no matter what) + Marginal Consumption as a function of discretionary income
1/Marginal Consumption as a function of discretionary income = marginal propensity to save
Japan has a very high savings rate - part of the way that manifests itself is in companies reducing debt. High savings rate = lower consumption = lower gdp.
This is a super basic view from the Keynesian framework. Reality is much less linear of course, and there are schools of thought that would argue these identies are hogwash. But that's where the conventional wisdom comes from.
posted by JPD at 6:36 AM on December 20, 2010
The backbone of explaining this is the identity for GDP
http://en.wikipedia.org/wiki/Gross_domestic_product = c + I +g +(x-m)
I= investment
g= government spending
x-m = net exports.
c = Consumption
c= Autonomous Consumption (money that gets spent no matter what) + Marginal Consumption as a function of discretionary income
1/Marginal Consumption as a function of discretionary income = marginal propensity to save
Japan has a very high savings rate - part of the way that manifests itself is in companies reducing debt. High savings rate = lower consumption = lower gdp.
This is a super basic view from the Keynesian framework. Reality is much less linear of course, and there are schools of thought that would argue these identies are hogwash. But that's where the conventional wisdom comes from.
posted by JPD at 6:36 AM on December 20, 2010
The conventional wisdom is that savings, be they corporate or individual, are just collecting dust and not contributing in a positive way to the economy. Any cash that is saved is cash that could otherwise be used for investment, e.g machinery. Without this increase in investment, when looked at from the perspective of the increase in potential output from the purchase of capital, the economy is said to not have grown (as much as it could have).
Essentially, when it comes to investments and savings, I think the rule of thumb is that savings are unproductive and bad for growth, while investments (in the right things) can be a very good thing, even if it has to take on the form of debt while doing so.
You might think of savings as the money in the bank. But those savings are subsequently loaned out by the bank to recirculate within the economy. Savings are cash that does not enter the economy in any form, think "cash in a tin box under your bed" kind of savings
P.S. This is what I have gathered from an informal study of economics over the last few years, I'd gladly be corrected if there're mistakes anywhere!
posted by titantoppler at 6:40 AM on December 20, 2010
Essentially, when it comes to investments and savings, I think the rule of thumb is that savings are unproductive and bad for growth, while investments (in the right things) can be a very good thing, even if it has to take on the form of debt while doing so.
You might think of savings as the money in the bank. But those savings are subsequently loaned out by the bank to recirculate within the economy. Savings are cash that does not enter the economy in any form, think "cash in a tin box under your bed" kind of savings
P.S. This is what I have gathered from an informal study of economics over the last few years, I'd gladly be corrected if there're mistakes anywhere!
posted by titantoppler at 6:40 AM on December 20, 2010
Titantoppler: when people talk about savings in this context, they are not talking about keeping cash under the mattress! Companies who are saving are either paying off debt or keeping cash on deposit.
posted by pharm at 6:53 AM on December 20, 2010 [1 favorite]
posted by pharm at 6:53 AM on December 20, 2010 [1 favorite]
Best answer: Here's an over-simplified illustration of the effect of saving versus spending on earnings.
Let's say I have $50. I'm worried about the economy and I don't trust banks so I just take the money and stick it under my mattress. End of story. No economic activity.
But let's say I'm not worried, so I decide to indulge myself. I spend the $50 on a massage. The masseuse in turn is very happy to have gotten an extra client, so he buys his girlfriend some new cashmere mittens on etsy. The knitter didn't expect this sale, so she takes the $50 and buys a crate of locally-produced pickled dandelion greens at the farmers' market. The farmer is shocked that anyone actually eats pickled dandelion greens, so he hadn't planned on having this $50. He uses the windfall to hire me to create an iPhone app for his farm (I do this at a discounted price of $50).
In this alternate scenario, what has that $50 done?
Next step: I have $50, but I borrow another $50. You can see where it goes from there. Now, this is idealized and oversimplified, but I believe it gives an idea of the role that debt and spending can play in getting the economy going.
posted by alms at 7:04 AM on December 20, 2010 [1 favorite]
Let's say I have $50. I'm worried about the economy and I don't trust banks so I just take the money and stick it under my mattress. End of story. No economic activity.
But let's say I'm not worried, so I decide to indulge myself. I spend the $50 on a massage. The masseuse in turn is very happy to have gotten an extra client, so he buys his girlfriend some new cashmere mittens on etsy. The knitter didn't expect this sale, so she takes the $50 and buys a crate of locally-produced pickled dandelion greens at the farmers' market. The farmer is shocked that anyone actually eats pickled dandelion greens, so he hadn't planned on having this $50. He uses the windfall to hire me to create an iPhone app for his farm (I do this at a discounted price of $50).
In this alternate scenario, what has that $50 done?
- The masseuse earned $50
- The knitter earned $50
- The farmer earned $50
- I earned an extra $50
Next step: I have $50, but I borrow another $50. You can see where it goes from there. Now, this is idealized and oversimplified, but I believe it gives an idea of the role that debt and spending can play in getting the economy going.
posted by alms at 7:04 AM on December 20, 2010 [1 favorite]
@pharm: The way I understand it is that paying off debt or keeping cash on deposit will in fact result in cash circulating through the economy. In the first scenario of paying off debt, the creditor will then have more money on hand to further invest, whereas in the second scenario, the bank will be taking that deposit to make loans. After all, banks don't keep 100% of their deposits on tap. Rather, in order to be able to make decent returns, they have to loan it out. This keeps the money flowing through the economy. Is my understanding of this flawed?
@alms: Your analogy of the loan and flow of money reminded me of this earlier Metafilter post.
To add on to alms:
For every dollar that circulates through the economy, the growth of the economy is not just $1. There exists this multiplier effect. Let's say all humans in this economy are alike, and their propensity to save is 20%. This means that for every dollar that they receive, they are likely to spend 80c and save 20c.
So let's say we start out with $100 as money in alms's pocket.
alms spends $80 on getting a massage.
My masseuse then spends $80*0.8 = $64 on his cashmere mittens
The knitter, having extra money, spends $64*0.8 = $51.2 on the dandelion greens
The farmer, having received this money, hires alms to create an iPhone app for $51.2*0.8 = $40.96
This ripple effect results in more than $100 of goods and services consumed, despite the injection of only $100 from alms, because they induced others to spend as well.
This is known as the growth multiplier, which explains why money that has not entered the economy is really just wasting away.
posted by titantoppler at 7:23 AM on December 20, 2010
@alms: Your analogy of the loan and flow of money reminded me of this earlier Metafilter post.
To add on to alms:
For every dollar that circulates through the economy, the growth of the economy is not just $1. There exists this multiplier effect. Let's say all humans in this economy are alike, and their propensity to save is 20%. This means that for every dollar that they receive, they are likely to spend 80c and save 20c.
So let's say we start out with $100 as money in alms's pocket.
alms spends $80 on getting a massage.
My masseuse then spends $80*0.8 = $64 on his cashmere mittens
The knitter, having extra money, spends $64*0.8 = $51.2 on the dandelion greens
The farmer, having received this money, hires alms to create an iPhone app for $51.2*0.8 = $40.96
This ripple effect results in more than $100 of goods and services consumed, despite the injection of only $100 from alms, because they induced others to spend as well.
This is known as the growth multiplier, which explains why money that has not entered the economy is really just wasting away.
posted by titantoppler at 7:23 AM on December 20, 2010
You may find this wikipedia article relevant: Paradox of Thrift.
posted by stuart_s at 11:20 AM on December 20, 2010
posted by stuart_s at 11:20 AM on December 20, 2010
Economics is complicated, as some of the other answers have probably shown you, and The Economist tends to assume that you know a fair bit about it.
To understand why something that's a good policy for a single company like Google isn't necessarily good for an entire economy like Japan (or the US), try this Harvard Business Review article by Paul Krugman:
A Country is Not a Company.
He makes many interesting points, and there's plenty of food for thought. For example, Google can quite conceivably expand 40% in one year. But the economy as a whole cannot do that because for Google to expand at that rate, it has to be pulling in new staff that used to work elsewhere, pulling in revenues that it's customers were previously spending elsewhere etc. So while there's some net growth, overall someplace else (say newspapers) had to be shrinking by simple virtue of the arithmetic.
The simplest way to start getting a handle on why saving might reduce growth in some circumstances is to get this basic idea that's at the heart of macroeconomics:
Everyone's spending is someone else's income.
Likewise, everyone's income is someone else's spending.
So, if everyone is trying to save more at the same time, i.e. spending less, that means everyone is also earning less. Then as everyone sees their income falling, they will cut back their spending even more, leading to a downward spiral. Eventually some "equilibrium" may be reaches in this downward spiral, where everyone is now earning less than when this process started, i.e. the economy has shrunk.
This is a simplified version, but probably enough to give you an idea of why more saving isn't always a good thing.
posted by philipy at 11:47 AM on December 20, 2010
To understand why something that's a good policy for a single company like Google isn't necessarily good for an entire economy like Japan (or the US), try this Harvard Business Review article by Paul Krugman:
A Country is Not a Company.
He makes many interesting points, and there's plenty of food for thought. For example, Google can quite conceivably expand 40% in one year. But the economy as a whole cannot do that because for Google to expand at that rate, it has to be pulling in new staff that used to work elsewhere, pulling in revenues that it's customers were previously spending elsewhere etc. So while there's some net growth, overall someplace else (say newspapers) had to be shrinking by simple virtue of the arithmetic.
The simplest way to start getting a handle on why saving might reduce growth in some circumstances is to get this basic idea that's at the heart of macroeconomics:
Everyone's spending is someone else's income.
Likewise, everyone's income is someone else's spending.
So, if everyone is trying to save more at the same time, i.e. spending less, that means everyone is also earning less. Then as everyone sees their income falling, they will cut back their spending even more, leading to a downward spiral. Eventually some "equilibrium" may be reaches in this downward spiral, where everyone is now earning less than when this process started, i.e. the economy has shrunk.
This is a simplified version, but probably enough to give you an idea of why more saving isn't always a good thing.
posted by philipy at 11:47 AM on December 20, 2010
@pharm: My apologies. I just dug out my Sloman's Economics and checked out the circular flow. While I was right to say that savings are considered a withdrawal from the circular flow of income, they are definitely not the cash-under-the-mattress kind of saving, as you have very rightly pointed out. Sloman says that the savings are deposited in banks and such, but these are subsequently re-invested and hence are considered a separate injection.
So, for the OP: please ignore my cash-under-the-mattress analogy. However, the premise that money being saved is a withdrawal from the flow of income, which may or may not be re-invested (we count that as a separate injection), which thus does not contribute to the income in a productive fashion.
Sorry for the confusion!
posted by titantoppler at 8:56 PM on December 20, 2010
So, for the OP: please ignore my cash-under-the-mattress analogy. However, the premise that money being saved is a withdrawal from the flow of income, which may or may not be re-invested (we count that as a separate injection), which thus does not contribute to the income in a productive fashion.
Sorry for the confusion!
posted by titantoppler at 8:56 PM on December 20, 2010
One of the issues with a lack of debt in the private economy is that debt servicers -- banks, credit card companies, and others -- have no way to make money. We've just been through the opposite problem in the US, of course, and got ourselves in a pickle where there was lots of private debt and a very low savings rate. This represented very high consumption, so -- pardon me if I'm misremembering -- this means that the money in the economy was more efficient, having a higher velocity^. Somebody would tap their home equity to buy an SUV. GM makes money. The dealer makes money. The somebody uses their SUV in business and makes money. They all pay employees. The employees spend their money. And so forth.
When you don't have debt, the banks don't have any income from that debt, so they can't lend money when somebody comes to them with all their wonderful home equity (representing "savings" in this example). So all of those transactions now cannot take place.
It seems counterintuitive, but that's essentially what is happening to Japan. Nobody has any debt anymore, but nobody can lend money anymore either -- because nobody has any debt.
What is happening here in the US now is that the credit disinflation is having a similar effect on the financial sector. They were given all this TARP and QE2 and whatnot, but because they are finding so many of their loans (most people would read this as assets, but in a more practical sense they're income streams) are bad, they don't dare lend out the money they have, even though it would give them another income stream. Worse, it's possible the shock of this downturn has led to a new appreciation of the costs of debt for Americans, so they will turn to the financial sector less often in the future. This has serious implications for the future strength of investment that will be needed to create the jobs that are now missing. So our problems are not that dissimilar, alas (although we have some way to go before being backed into the same corner as Japan).
posted by dhartung at 11:48 PM on December 20, 2010
When you don't have debt, the banks don't have any income from that debt, so they can't lend money when somebody comes to them with all their wonderful home equity (representing "savings" in this example). So all of those transactions now cannot take place.
It seems counterintuitive, but that's essentially what is happening to Japan. Nobody has any debt anymore, but nobody can lend money anymore either -- because nobody has any debt.
What is happening here in the US now is that the credit disinflation is having a similar effect on the financial sector. They were given all this TARP and QE2 and whatnot, but because they are finding so many of their loans (most people would read this as assets, but in a more practical sense they're income streams) are bad, they don't dare lend out the money they have, even though it would give them another income stream. Worse, it's possible the shock of this downturn has led to a new appreciation of the costs of debt for Americans, so they will turn to the financial sector less often in the future. This has serious implications for the future strength of investment that will be needed to create the jobs that are now missing. So our problems are not that dissimilar, alas (although we have some way to go before being backed into the same corner as Japan).
posted by dhartung at 11:48 PM on December 20, 2010
Response by poster: Thanks MeFi, excellent range of answers as always!
posted by pandabearjohnson at 5:41 AM on December 21, 2010
posted by pandabearjohnson at 5:41 AM on December 21, 2010
Banks don't really need deposits in order to lend: the lending comes first, deposits follow (and if they don't, the bank goes running to the central bank to cover their liquidity needs).
Sadly at the moment, if the Fed graphs are to be believed, the money multiplier has gone below 1. Which is unprecedented.
posted by pharm at 7:48 AM on December 21, 2010
Sadly at the moment, if the Fed graphs are to be believed, the money multiplier has gone below 1. Which is unprecedented.
posted by pharm at 7:48 AM on December 21, 2010
This thread is closed to new comments.
posted by natasha_k at 6:31 AM on December 20, 2010