“Maintaining and expanding a nation’s stock of capital requires saving.” Evaluate and explain. Is the assumption of full employment of any relevance?
Capital Stock is the level of productive capacity in the economy.
Saving and Investment
- There is an important economic idea that Savings = Investment. The logic is that without bank deposits, banks are not in a position to lend money for investment.
- An economy with a low savings ratio has little funds to finance investment because it is all being used to finance current consumer spending.
However, higher levels of saving do not necessarily lead to more investment. The extra saving may not encourage people to invest more. E.g. In the great depression, individual savings did not encourage investment. Keynes called this the paradox of thrift
Keynes said that an important factor in determining investment was, not so much levels of savings, but peoples attitude to the future of the economy.
This is perhaps why full employment is important. In a recession, extra savings may just be saved and not used to finance resources. However, when the economy is close to full employment, extra savings are important for financing extra investment.
Another factor is financing investment from abroad. E.g. the UK has a current account deficit but, the UK has also been able to attract capital investment from abroad e.g. Japanese firms investing in the UK.
Does Saving influence the Growth Rate?
Some economic models suggest that low saving rates will imply a low long-term rate of economic growth. If savings are low, then this will hamper long-term investment and the capital stock will increase at a lower rate.
Saving, Investment and Current Account
The Current account measures the net value of exports + net investment incomes from abroad. For accounting purposes, the current account also equals = domestic saving – domestic investment.
If domestic investment is substantially higher than domestic saving, then it needs to be financed by capital inflows from abroad ( A surplus on the financial / capital account and a deficit on the current account.