Personal Finance

Growing your business through savings

People and companies tend to save and invest if
People and companies tend to save and invest if they can trust the institutions that manage their money and the economy at large. FILE PHOTO | NMG 

How do countries and individuals become rich? If it is through saving, then it is a process of setting aside a portion of current income for future use, or the flow of resources accumulated in this way over a given period of time. Saving may mean increases in bank deposits, purchases of securities or increased cash holdings. The extent to which individuals, organisations or countries save is affected by their preferences for future over present consumption, their expectations of income and to some extent, by the rate of interest.

Saving has become central to individual and collective prosperity. As a rule of thumb, those who save more become wealthier because foregoing consumption today allows one to invest in the future. Businesses can invest in new equipment and governments in new roads, schools and health facilities. All of these investments are associated with better economic futures.

People and companies tend to save and invest if they can trust the institutions that manage their money and the economy at large. In the past, it was not always safe to keep deposits in banks in many African countries. It is different today. In fact some may feel more secure entrusting their savings to African banks than those in Europe.

But you need more than robust and credible banks for increasing savings and investments. Investors will only enter and stay in large numbers if they can trust that the state won’t change the rules of the game mid-course.

In principle, there is nothing wrong with a savings investment culture. Higher savings can help finance higher levels of investment and boost productivity over the longer term.

If people save more, it enables the financial institutions to lend more to firms for enterprise. An economy where savings are very low means that it is choosing short-term consumption over long-term investment. To starve the economy of investment can lead to future bottlenecks and shortages.

Poorer countries save less than rich ones just like households because a greater share of their income goes to immediate consumption. Richer countries also have an increasingly large group of retirees who tend to stash money aside. But some poor countries have broken out of the cycle of low savings and high consumption, especially so in East Asia. There, high savings and investment have fuelled the economic boom. China is an extreme case: more than half of what is produced is saved and then invested. But even a relatively poor country like Vietnam can boast having a savings rate of 33 percent. Nobel-prize winner Joseph Stiglitz, argues that besides cultural factors, it is high growth that explains high savings in East Asia. Clearly there is a virtuous cycle between economic growth and saving.

The Harrod-Domar model of economic growth suggests the level of savings is a key factor in determining economic growth rates.

Saving is important to the economic progress of a country because of its relation to investment. If there is to be an increase in productive wealth, some individuals must be willing to abstain from consuming their entire income. Progress is not dependent on saving alone; there must also be individuals willing to invest and thereby increase productive capacity. In most of Africa, savings rates are relatively low, around 17 percent of gross domestic product.

We tend to think of savings as good and virtuous; and at the right time, it is. But, if everyone saves at once, it can cause a drop in aggregate demand and cause a recession. Keynes called it the Paradox of Thrift. There is also the paradox of savings. People save more when they think it is a bad time to save and save less when it is a good time to do so. It reminds us of good old St Augustine – make me chaste (a good virtuous saver), but not just yet. So yes, there’s nothing wrong with encouraging a decent level of savings, but we shouldn’t make higher savings a priority when you’re trying to end five years of economic stagnation. In the boom period 2000-2007, more saving would have been helpful. But, not in the period of economic recovery post 2007.

What can be done to boost saving? Three stakeholders must be convinced to put money aside; households, companies and the government. There are at least three ways the government can act to increase savings and thereby generate more investment. First, it can strengthen property rights, especially around land titling, which will promote greater saving and investment by households in real estate.

Second, it can take measures to improve the business environment and address infrastructure bottlenecks especially energy and transport, so that business will have an incentive to save more and invest in new projects. Third, it can continue the shift in public expenditures and spend more on infrastructure than on wages, goods and services.