Sun Bae Kim

English

Research Papers in Economics

FRBSF WEEKLY LETTER
Number 93-08, February 26, 1993
Saving-Investment Linkages
in the Pacific Basin
In the last two decades continuing deregulation
has opened up international capital markets.
What does this greater freedom of capital move-
ment among countries imply about the relation
between national saving and investment? Theo-
retically the answer is straightforward: With
greater capital mobility, a country's level of in-
vestment need not be constrained by the level of
domestic saving, since any shortfall can be fi-
nanced by foreign saving. Thus, the dismantling
of capital controls should have loosened the link
between national saving and investment rates.
But the empirical evidence has not supported
this conclusion. In a widely cited cross-country
study, Feldstein and Horioka (1980) found that
the investment rate is highly correlated with the
saving rate, which suggests that capital is less
mobile internationally than commonly presumed.
Subsequent work has found no evidence of any
decline in the saving-investment correlation over
time. Moreover, the correlation appears to be
stronger for industrialized countries than for de-
veloping countries, even though industrialized
countries tend to have more developed financial
markets and fewer restrictions on international
transactions.
This Letter examines saving-investment linkages
in a group of Pacific Basin countries and also
finds that the degree of capital controls has rela-
tively little impact on the relation of domestic
investment and saving. This puzzling result is ex-
plained in terms of the response of government
policy to capital flows and the associated current
account imbalances. Governments in countries
with fewer capital controls have tended to coun-
teract current account imbalances through fiscal
policy intervention because of an aversion to
large imbalances. Large capital inflow may be
deemed undesirable, for example, because it
causes the exchange rate to appreciate which, in
turn, weakens the export sector. Such a policy
response toward external imbalances has damp-
ened differences in investment and national
saving rates. In countries with a high degree of
capital controls, on the other hand, governments
have tended not to offset curre.nt account im-
balances with fiscal policy, but rather to finance
government deficits through foreign borrowing.
This has loosened the link between national sav-
ing and investment in these countries.
Capital controls in the Pacific Basin
While the degree of capital controls eludes pre-
cise measurement, it is possible to classify Pacific
Basin countries into three broad groups accord-
ing to how early deregulation was initiated and
how quickly capital controls were dismantled.
(For details, see Kim 1993). At one end of the
spectrum are Canada, the U.S., Hong Kong, and
Singapore, with a relatively low degree of capital
controls. The u.s. and Canada have long had a
well-developed financial system relatively un-
encumbered by regulations, domestically as well
as internationally. Hong Kong and Singapore
removed most capital controls in the early to
mid-1970s in a bid to become international
financial centers.
The second group, Korea, Taiwan, and the Philip-
pines, lies at the opposite end of the spectrum.
Korea and Taiwan did not initiate any significant
liberalization until well into the 1980s, and sub-
stantial barriers to international capital mobility
still remain in both countries. In the Philippines,
a policy of liberalizing capital controls was re-
versed abruptly in 1983 with the advent of the
international debt crisis.
The third group, Australia, Indonesia, Japan,
Malaysia, New Zealand, and Thailand, falls
somewhere in the middle of the spectrum. All six
countries initially had stringent international cap-
ital exchange controls. Indonesia, Malaysia, and
Thailand began liberalizing controls in the early
1970s but restrictions still remain. Japan began
relaxing capital controls in the mid-1970s. As
with domestic financial liberalization, however,
the process has been gradual and still is ongoing.FRBSF
By contrast, Australia and New Zealand did not
begin liberalization until the early 1980s, but
once initiated, regulatory barriers to capital
mobility were dismantled quite quickly.
Effects on saving-investment linkages
It is natural to expect that the degree of capital
controls is an important determinant of invest-
ment's response to national saving. To see why,
consider two extreme cases. If capital controls
prevent a country from borrowing internationally,
all investment within the country must be fi-
nanced out of its own saving; in other words,
national saving and investment rates will be per-
fectly correlated. Suppose on the other hand that
there is no impediment to capital flows, as is the
case within national borders. For example, if in-
vestment opportunities are different in New York
and California, and if residents in both states can
freely borrow or lend across state lines, the sav-
ing rate in New York or California need not be
related to the state's investment rate. By the same
analogy, if a nation's saving decision is based on
a different set of considerations from those guid-
ing its investment decisions, one would expect
no systematic relation between national saving
and investment, provided international capital
markets are fully integrated.
Figure 1 illustrates the extent to which the degree
of capital controls in Pacific Basin countries ex-
plains observed differences in the response of
domestic investment to saving. The three groups
of countries are arranged along the horizontal
axis in ascending order of capital controls. The
vertical axis measures the sensitivity of a coun-
try's investment rate to a change in its saving
rate, 13, as estimated from the regression of invest-
ment on saving. For example, a value of 13 equal
to 0.5 indicates that a 1 percent increase in the
national saving rate leads to a 0.5 percent in-
crease in the investment rate; a value of 1 implies
that any given change in saving is fully reflected
in the change in investment.
The strength ofthe saving-investment linkage
in Pacific Basin countries does not appear to be
systematically related with the degree of capital
controls. If anything, the linkage tends to be
stronger in the group of countries with the lowest
degree of capital controls. The regression coeffi-
cient on saving is close to 1 in Canada and the
U.S. despite their having some of the least restric-
tive policies with respect to international capital
flows. Japan, a country classified as having an
intermediate degree of capital controls, also has
a 13 that is not significantly different from 1. By
contrast, significantly weaker saving-investment
linkages are observed for Korea, Thailand, and
the Philippines, despite the fact these countries
traditionally have much more stringent capital
controls.
Figure 1: Capital Controls and the
Response of Investment to Saving (13)
1.0 • • Can • Jap
0.8
USA:
0.6 • • Tha
~
Hko '. 0.4 :Kor • Phi
0.2 • Ind .' NZ: Tai • 0.0 • ;AUS Mal
Sog •
-0.2
Low Intermediate High
Degrees of Capital Control
Explaining the puzzle
One possible explanation for this puzzling result
is that correlations between saving and in~est­
ment also may reflect some common exogenous
disturbances affecting the economy. For example,
even with perfect capital mobility, changes in
population growth, productivity, or the growth
rate of income all may generate co-movements
in saving and investment, thus giving the appear-
ance of immobile capital. Additionally, imperfect
integration of goods markets or other factors of
production may force the economy to behave
more like a closed economy in terms of saving
and investment. However, adjusting for some of
these effects did not materially alter the puzzling
cross-country pattern of saving-investment link-
ages in the Pacific Basin.
An alternative explanation is that some govern-
ments are averse to large capital inflows or out-
flows, that is, to current account imbalances, and
adjust their budget deficits to offset the gap be-
tween private saving and investment. This is not
to say that fiscal policy is determined exclusively,
or even primarily, by balance of payments con-
siderations. Rather, the explanation presumes that
when the current account balance exceeds some
predetermined level, then fiscal or monetary pol-
icies are implemented to reduce or eliminate
those deficits or surpluses. For example, in the
second half of the 1980s, the U.S. tried to reduce
fiscal spending and thereby reduce its growing
current account deficit; on the opposite side of
the coin is Japan which sought to reduce the cur-rent account surpluses that emerged in the sec-
ond half of the 1980s by pursuing expansionary
fiscal and monetary policies.
To assess the plausibility ofthis argument, Figure 2
plots the saving-investment linkages against a
variable <1>, which measures the propensity of
government policy to counteract large external
imbalances. <I> is estimated by regressing govern-
ment budget deficit on the gap between private
saving and investment. A value of <I> equal to 1
implies that fiscal policy completely offsets any
imbalance in private saving and investment so
that no net capital flow occurs. In the polar op-
posite case of <I> equal to 0, fiscal policy does
not change in response to current account
imbalances.
Figure 2: Fiscal Policy Response to Current Account
Imbalances (<1» and Response of Investment to Saving (13)
1.21,--------------------,
1.0 • • Can
Jap • USA
0.8
0.6 ·Hko
e Tha
13 • Kor
0.4 • Phi
0 2 • Ind
• Tai
• NZ
0.0
Aus • Sng
• Mal
-0.2
0.0 0.2 0.4 0.6 0.8 1.0
<j>
The government's propensity to offset current
account imbalances (<1» tends to be stronger in
countries (such as Canada, the U.s., and Japan)
with a higher saving-investment correlation ([3).
Thus, despite the low or intermediate degree of
capital controls in these countries, the policy re-
sponse to maintain external balance has tended
to raise the saving-investment correlation. Con-
versely, because the propensity to offset current
account imbalances tended to be lower in coun-
tries that traditionally imposed higher restrictions
on international capital flows (such as Taiwan,
the Philippines, Indonesia, and Malaysia), the
saving-investment correlation has tended to be
relatively weak or insignificant in these countries.
In fact, there is evidence suggesting that for this
latter group of countries, the government itself
has played a central role in the flow of foreign
borrowing, thus driving a wedge between na-
tional saving and investment. For the five coun-
tries for which data are available (Indonesia,
Korea, Malaysia, the Philippines, and Thailand)
public or publicly guaranteed debt accounted for
one-half to three-quarters of total foreign borrow-
ing throughout the 1980s, with significant propor-
tions of the foreign borrowing going toward fi-
nancing the government budget deficit. Though
comparable data are unavailable for the earlier
periods, the relative importance of public bor-
rowing was undoubtedly even higher. This may
constitute an additional reason for why saving-
investment linkages are weaker in these Pacific
Basin countries despite their traditionally more
stringent controls.
Conclusion
Theory suggests that the greater the degree of
capital controls, the more investment will be
constrained by the availability of domestic sav-
ing. An examination of Pacific Basin countries
suggests, however, that the relationship turns out
to be more complex. Countries with few capital
controls exhibita relatively high saving-investment
linkage, that is, lower net capital mobility, if the
government pursues a fiscal policy that tends to
offset imbalances in private saving and invest-
ment. Canada, the U.s., and to a lesser extent
Japan, fall into this category. By contrast, net in-
ternational capital movements can be substantial
despite stringent capital controls if the govern-
ment itself is the primary agent that borrows in
the international capital market. This was the
case for Indonesia, Korea, Malaysia, the Philip-
pines, and Thailand, where the public sector has
traditionally played a relatively larger role in al-
locating domestic investment. For this group of
countries, capital controls, by preventing private
capital outflow, may have in fact accentuated the
imbalance between total saving and investment.
Sun Bae Kim
Economist
References
Feldstein, M., and C. Horioka. 1980. "Domestic Saving
and International Capital Flows." Economic Journal
30 Uune) pp. 314-329.
Kim, S.B. 1993. "00 Capital Controls Affect the Re-
sponse of Investment Saving? Evidence from the
Pacific Basin:' Federal Reserve Bank of San Fran-
cisco Economic Review, forthcoming.
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor or to the author.... Free copies of Federal Reserve publications can be
obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 974-2246, Fax (415) 974-3341.OlL176 \I) 'o:>sPUI?J:l UI?S
lOLL xog 'O'd
O)SI)UOJ::J UOS
JO >1U08
al\JaSa~ IOJapa::J
~uaw~Jodaa LpJOaSatJ
Index to Recent Issues of FRBSF Weekly Letter
DATE NUMBER TITLE AUTHOR
9/4
9/11
9/18
9/25
10/2
10/9
10/16
10/23
10/30
11/6
11/13
11/20
11/27
12/4
12/11
12/25
1/1
1/8
1/22
1/29
2/5
2/12
2/19
92-30
92-31
92-32
92-33
92"34
92-35
92-36
92-37
92-38
92-39
92-40
92-41
92-42
92-43
92-44
92-45
93-01
93-02
93-03
93-04
93-05
93-06
93-07
Money, Credit, and M2
Pegging, Floating, and Price Stability: Lessons from Taiwan
Budget Rules and Monetary Union in Europe
The Slow Recovery
Ejido Reform and the NAFTA
The Dollar: Short-Run Volatility and Long-Run Adjustment
The European Currency Crisis
Southern California Banking Blues
Would a New Monetary Aggregate Improve Policy?
Interest Rate Risk and Bank Capital Standards
NAFTA and U.S. Banking
A Note of Caution on Early Bank Closure
Where's the Recovery?
Diamonds and Water: A Paradox Revisited
Sluggish Money Growth: japan's Recent Experience
Labor Market Structure and Monetary Policy
An Alternative Strategy for Monetary Policy
The Recession, the Recovery, and the Productivity Slowdown
U.S. Banking Turnaround
Competitive Forces and Profit Persistence in Banking
The Sources of the Growth Slowdown
GDP Fluctuations: Permanent or Temporary?
The Twelfth District Agricultural Outlook
judd/Trehan
Moreno
Glick/Hutchison
Throop
Schmidt/Gruben
Throop
GIick/Hutchison
Zimmerman
Motley
Neuberger
Laderman/Moreno
Levonian
CromwelllTrenholme
Schmidt
Moreno/Kim
Huh
Motley/judd
Cogley
Zimmerman
Levonian
Motley
Moreno
Dean
The FRBSF Weekly Letter appears on an abbreviated schedule in june, july, August, and December.

974-2246, Fax (415) 974-3341.OlL176 \I) 'o:>sPUI?J:l UI?S lOLL xog 'O'd O)SI)UOJ::J UOS JO >1U08 al\JaSa~ IOJapa::J ~uaw~Jodaa LpJOaSatJ Index to Recent Issues of FRBSF Weekly Letter

Domestic Saving and International Capital Flows.&quot;

Saving-investment linkages in the Pacific Basin

http://www.frbsf.org/publications/economics/letter/1993/el93-08.pdf

Saving-investment linkages in the Pacific Basin

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics