Saturday, November 06, 2010

Paradox of Savings….

Paradoxes are everywhere in this world. Recently came across this term ‘Paradox of Savings’.  It’s one of the paradox of economics. Popularised by the father of Keynesian Economics, John Maynard Keynes, according to the Wiki, “The paradox states that if everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth.”

To explain this, the Wiki says, “If a population saves more money, then total revenues for companies will decline. This decrease in economic growth means fewer salary increases and perhaps downsizing. Eventually the population's total savings will have remained the same or even declined because of lower incomes and a weaker economy.” In short, increase in individual’s saving may be harmful to the economy.

Admittedly in economics there are many ‘factions’ or ‘schools of thought’. This view is from the Keynesian School of Thought. Others may beg to differ.

So what do we do? Encourage savings or discourage it? I am not an economist to answer this. It’s up to individuals which faction they want to believe. But what’s interesting is how we Asians specifically the Chinese think of savings compare to the Americans.

Michael Pettis in his article ‘Chinese Savings and the Wealth Effect’ discussed why the savings rate in China is very high and why savings rises when interest rates decline. By commonsense, when interest rate increases savings will increase. But not in China. The author shared that in China savings are meant for things like education. Parents will have a specific target that will cover their children’s education. This will be calculated taking into account interest rates for a monthly amount to be saved. Hence when interest rates decline, they will have to increase their monthly savings to cover the gap resulting from the decline in rate.

Culture seems to play an important role here. One thing it thought me, you have to wear many ‘glasses’ to see the true picture. The world seems different when seen through an economist’s eyes but not necessarily the complete picture…..