Last Wednesday was World Savings Day. This was established in 1924 with the objective of promoting savings all over the world. In their efforts to promote thrift the savings banks also worked with the support of the schools, the clergy, as well as cultural, sports, professional, and women’s associations.
Culturally, we have always considered savings and thrift as something virtuous. However, from an economic perspective this is not always considered so. John Maynard Keynes – a British economist whose ideas changed dramatically the theory and practice of the economic policies of governments – had argued that the proper response to an economic recession is more spending, more risk-taking and fewer savings.
He has advised the US President of the time that for the US to recover from the Great Depression of the 1930s, the US Government had to stimulate consumer and investment spending.
He coined the phrase, “the Paradox of Thrift”. It has been called so because, even though it makes sense for individuals and households to reduce consumption during difficult economic times, this is the wrong prescription for the larger economy. The answer to unemployment is more spending and not more savings, as spending represents an injection of money into the economy while savings represent a withdrawal of money from the economy.
Those who follow the political situation in Italy know that this is a major issue between Italy and the European Union. The Italian Government wants to adopt a budget that promotes spending to stimulate economic growth, while the EU is saying that this is the wrong approach.
As students of economics know, the Keynesian model is based on the theory of the circular flow of income, which states that an increase in current spending drives future spending. Current spending leads to more income for producers. These producers expand their business and hire new workers. These new workers earn new incomes, which is then spent, leading to further growth.
In Malta, thrift is considered a virtue
There are economists who do not subscribe to such a theory as they consider it flawed. The main point put forward against the theory of the circular flow of income and the paradox of thrift, is that it ignores the potential for saved income to be lent out by banks. There can only be investment expenditure if businesses borrow money from credit institutions. These credit institutions can only lend money to businesses if consumers would have saved money and deposited it with such institutions. So less saving means less investment and lower economic growth.
As with most things in economics the answer is not in black or white terms. Here are times when savings are good for the economy and times when they are not. It also needs to be understood that what applies to a large economy does not necessarily apply to a small economy and what may apply to an open economy such as ours does not necessarily apply to a more closed economy.
For Malta there are points to consider. A low savings rate may mean that persons are living beyond their means. They are spending more than they are earning and have nothing to shield them when the rainy day comes. For an economy that is small, very open and very reliant on foreign direct investment – and therefore not large enough to mobilise the required large resources when the rainy day comes – a low savings rate may present a problem.
A second consideration is the structure of our economy. It is true that our economy is reliant on foreign direct investment – however it is also true that small enterprises and family businesses are a very important part of our economic fabric. These require capital which they can only source locally, and as such cannot run the risk of being crowded out of the market by larger investors because of a low savings rate.
On the other hand we also need to consider that in Malta there is a great amount of money which is saved. Apart from money held in savings account, one also needs to take into consideration the monies invested in government and corporate bonds. To this we need to add monies held with collective investment schemes and pension schemes. Then there are monies invested in shares. Although they are not classified as savings, the source of these funds is all too often past savings.
Finally, we also need to consider what is probably the major savings plan of most Maltese – owning their own home. When one adds all this up, the amounts do make up a staggering amount, which probably has never been accurately quantified. Thrift is still considered a virtue in our country.
Not enough is usually said about the savings issue in Malta. It is a far less exciting subject than public sector spending or employment. However, we should always remember that savings is the source for investment expenditure. Without an adequate level of savings, our economy may lose the momentum it has.