Who’s Doing The Saving?

This recent paper from the World Bank confirms something I’ve suspected and been concerned about for a long time (abstract):

What are the causes of the growing trend of excess savings of the corporate sector in developed countries ? an empirical analysis of three hypotheses
Leandro Brufman, Lisana Martinez & Rodrigo Perez Artica

Summary: This paper analyzes annual accounting data for a sample of 5,000 publicly traded manufacturing firms from Germany, France, Italy, Japan, and the United Kingdom. The analysis uses data from 1997 to 2011 and finds an increasing trend of excess savings (defined as the difference between gross saving and capital formation) and a gradual decline of gross capital formation. This trend is accompanied by a steady deleveraging process and a decrease in the share of operating assets in total assets. This process is more acute among the more credit constrained, the more volatile, and the less dynamic firms.

So what’s the big deal? If corporations are saving more, that should be good right? Especially since both household and government sectors appear to have headed the other way.

Actually, from my perspective, higher corporate savings isn’t to be desired because it’s likely the cause of higher household and government debt.

To see why, consider the inter-linkages between these three sectors within the economy. Let’s posit the following:

1. Households provide labour and capital in return for wages and dividends, and consume goods. Excess income is saved via the banking system, and borrowings can be used to smoothen consumption over time.
2. Corporations produce goods, and pay out wages and dividends. Excess income can be saved, and borrowing can be used to finance investment.
3. Governments tax both corporations and households, and is responsible for full employment growth.

So let’s shock this system with an exogenous event, that suddenly causes corporations to increase their desired rate of saving at any given level of interest. This can be achieved in two ways, by either cutting costs or by reducing investment.

But cutting costs implies reducing wages or cutting employment, and cutting investment reduces future potential growth (and thus dividend growth). Moreover, higher savings reduces the rate of interest, making borrowing cheaper.

Households, faced with lower income prospects and borrowing costs, are tempted into increasing their leverage to maintain their standard of living. Governments, seeing employment and wages decrease or a reduced rate of investment, boosts spending (or cuts taxes) to maintain full employment growth. This is again made easier by cheaper borrowing costs, which allow for a higher level of deficit financing.

So, assuming the economy stays on a full employment equilibrium, the consequence of higher corporate savings morphs into higher household and government debt. And this is without even thinking about what the banking system itself is incentivised to do with cheaper money and less corporate investment opportunities.

Nasty, isn’t it?

The way out of this mess is to somehow get corporations to reduce their savings rate and get them investing again. But then we come up against a pressing question – in the real world, why have corporations reduced their leverage and increased their savings?

If it was just Malaysia, I would say the 1997-98 financial crisis would have been a sufficient motive. But higher corporate savings is a global phenomenon not a local one, implying that we need to look at contributory factors at the global level.

Globalisation itself could thus be a culprit – as firms expand across national boundaries, the increasing complexity and uncertainty of managing a business covering many different regulatory jurisdictions with varying levels of economic development (something confirmed by MNC CEO surveys) make increasing savings a prudent thing to do. Another candidate is that as finance became more internationalised, credit for domestic firms became less appealing for banks to manage, leaving internally generated funds (i.e. savings) as a more palatable source for financing investment.

The financialisation of many commodities and the mania for market “efficiency” (e.g. computerised trading) have greatly increased commodity market volatility, which could be driving corporate uncertainty. Commodity prices and price volatility have generally increased about the same time as corporate savings increased.

I’m speculating here. It could be any or all or none of the above. Many questions, few answers.

Technical Notes

Brufman, Leandro and Lisana Martinez & Rodrigo Perez Artica, "What are the causes of the growing trend of excess savings of the corporate sector in developed countries ? an empirical analysis of three hypotheses", World Bank Policy Research working paper no. WPS 6571, August 2013