There are three main theories explaining the phenomenon of savings by households. According to the first theory, savings results from the choice between consumption in the present and consumption in the future. Individuals
compare their rate of time preference and the interest rate, and smooth their consumption over time in order to maximize the benefit. Under this theory, the interest rate is the main determinant of the variability in savings rates.
The second approach is based on the perception of a close correlation between current income and consumption, where the difference between them denotes savings. Under this approach, the main factor affecting savings is the change in the level of income.
The third approach represents a combination of the
first two theories, and regards the smoothing of consumption over time as deriving from its comparison to the income which the individual would perceive as his/her permanent income. (The latter is not necessarily the same as his income at a given point in time.)
Factors affecting savings include:
The level of the real interest rate
In any attempt to identify the factors behind a higher or lower rate of savings, the first possibility to be considered will undoubtedly be the interest rate, which is the remuneration for saving.
Surprisingly enough, neither the actual findings or the theory regarding the direction in which this
factor acts are clear-cut. While a higher interest rate will make it more worthwhile to save, it is also likely to reduce saving, for example, in cases where individuals' allocations to pension schemes decline as the result of a rise in the interest rate (in the case of defined benefits pension schemes). Moreover, a rise in the interest rate increases the value of households' assets, and can therefore lead to a reduced tendency to save.
Empirical findings obtained in practice do not point to a significant correlation between the interest rate and savings.
The level of per capita GDP
One of the most obvious phenomena emerging from a comparison between different countries' savings rates is the positive correlation between savings and the level of per capita GDP. Very low income-earners utilize all their
income in order to purchase the most basic commodities. Higher income-earners are able to purchase luxury goods. At the very highest income levels, households do not need to use all their income for consumption and part of
their income is set aside for the purpose of savings.
An international comparison shows that the ratio between the level of per capita income and the
rate of savings is not linear - in economies with a high level of per capita income, the savings rate does not continue to rise, but levels off or even falls slightly.
Fiscal policy
According to the economic theory known as the Ricardian equivalence, a decline in public savings will be offset by a rise in private savings. In other words, a growth in public consumption (or from the longer term viewpoint, a
growth in the public debt), which implies a decrease in public savings, will cause individuals to change their savings habits and increase their savings, in
order to create a reserve against the future tax burden, (which is likely to grow).
Another explanation of why private savings increase when public saving declines brings us back to the interest rate variable. Since a reduction in public savings will increase the public debt, the borrowing requirement will
also increase and may lead to a rise in the interest rate and, in certain conditions, to a rise in private savings.
The third reason for this phenomenon is the substitution between public consumption and private consumption. As a
clear example, when a high level of health and education services is supplied by the state, the population will expend less on the consumption of these services. Empirical findings show that the offset of the differences between
public and private savings is not total, and usually amounts to 50%. That is, a one percentage point decrease in public savings will lead to a rise in private savings of half a percentage point. It was also found that the rate of offset
is higher in countries where the public sector is notable for negative rates of savings.
Data on savings in Israel over the past fifteen years point to a significant negative correlation, whereby the rate of private savings rises by three quarters of a percentage point when the rate of public savings falls by one percentage point. Accordingly, an expansionary fiscal policy, under which public consumption increases, can be expected to lead to a decline in public savings and to a smaller rise in the rate of private savings. The net result
will be a reduction in the rate of aggregate national savings.
The proportion of labor remuneration in national income
Another major cause of the decline in savings, is a change in the distribution of national income between remuneration for labor and non-labor remuneration. During the past fifteen years, the proportion of labor remuneration to total income has risen while the proportion of income from property has fallen. The clear negative correlation between savings and the proportion of labor remuneration derives from the fact that the marginal tendency to consume from wage income is greater than the marginal tendency to
consume from non-wage income. In other words, if in a given year an individual's income increases due to a rise in his wages, private consumption
will increase (and private savings rate will decrease) more than in the case of
an identical rise in earnings deriving from a growth in income from property.
Households appear to perceive a change in their wages as a permanent change, while a change in income from property is regarded as a transitory change, which is not necessarily going to be permanent.
The reasons for the rise in the proportion of labor remuneration in recent years include:
- the large, 20%
increase in the number of employed persons over the past three years (and the
rapid fall of the unemployment rate);
- an overall rise in wages (a real
increase of 2.5% in the average wage per post in 1994,
- a real increase of
9.8% in public sector wages).
The distribution of income
An inequality in the distribution of income, as measured by the Gini coefficient, rose during the 1990's, due, among other things, to the wave of mass immigration. The arrival of such a large number of immigrants, most of whom came with few assets, had the effect of increasing the extent of inequality measured.
Once the pace of immigration slows and immigrants will
become economically established, income equality in Israel will increase. The positive correlation between the extent of inequality and the rate of private
savings is a well known phenomenon, and results from differences in the marginal propensity to save between higher-income and lower-income households.
The lower a household's income, the higher will be the proportion of this income utilized for consumption and the smaller will be the proportion
allocated to savings, and vice versa.
Financial reforms
Financial reforms usually have a temporarily adverse affect on savings rates. Israel is a good example of this phenomenon, in view of the wide-ranging
(if gradually implemented) financial reforms initiated since the 1985 stabilization program.
The most notable factor affecting savings during the
initial stage of this liberalization process was found to be the lifting of restrictions on the taking of credit. The much greater ease with which loans can be obtained, as a result of this reform measure, reduces the individual's
incentive to save. Subsequent reform measures increase the range of savings opportunities open to individuals, and the rate of savings can be expected to grow as a result.
Although the financial liberalization to which the economy has been and is being subjected certainly has an effect on savings. It is very hard to quantify this effect and isolate it from other macroeconomic developments which have occurred in the same period.
Uncertainty
A situation of uncertainty - whether political, economical or personal, will
generally have the effect of encouraging all economic units to increase their savings (on the other hand, uncertainty concerning a change in the financial climate might shift savings from financial to material, such as diamonds, real
estate, etc.). Households will be afraid that their future income decreases and hence they will display an increased tendency to save.
For the individual, increasing his/her savings is a form of insurance against the prospect of unemployment, the death of an income-earner, the need for increased medical
expenses, or against any other type of unexpected calamity.
All other conditions being equal (and under reasonable assumptions regarding insurance companies risk premium), any development leading to a reduction in uncertainty
(the introduction of health insurance or unemployment benefit, for example) will reduce the individual's propensity to save. In the United States, for
example, it was found that a very large proportion of private savings can be attributed to households' desire to insure themselves against unexpected medical
expenses.
The reduction of inflationary uncertainty has been cited as one of the reasons for the decline in industrialized countries' savings rates during
the past two decades. Another reason cited in this respect is the growth in women's rate of participation in the labor force - an additional earner in a household reduces uncertainty and the need to save for emergencies.
The effects of taxation
Taxes (and national insurance payments) reduce their payers' disposable income, and thereby have the effect of reducing private savings while increasing government revenue and savings. When the various channels of savings
are either subjected to taxation or are subsidized, another effect is apparent from the real interest rate after tax.
In Israel, exemption from capital gains
tax is granted on securities marketed on the stock exchange, provident fund interest, shekel deposits, saving schemes, foreign currency restitution deposits and life insurance proceeds. Tax benefits are also provided when
making a deposit in pension instruments.
Another relevant factor is the indirect taxation levied on consumption in Israel. Taxes such as customs duty,
purchase tax and VAT are an obstacle to consumption, thereby reducing its attractiveness and making it more worthwhile to save.
Demographic factors
One of the factors found to have a clear and significant effect on savings is the age composition of the population. This effect can be explained by the life cycle model, whereby savings are used for retirement and are accrued at
different rates during the individual's lifetime. Accordingly, we can expect the savings rate to decline in proportion to the size of the elderly population
who have retired from the labor market.
Given that savings among the very young
age groups are negligible, the model can be expanded. A country where the dependence ratio (defined as the percentage of the population aged below 15 and
above 65 divided by the working age population) is high, will have a savings rate lower than that of a country where the ratio is low, all other conditions being equal. (Savings rates will be highest at the 30-55 age level.) The same
applies when examining the situation in a given country over time.
In Israel, the dependence ratio amounts to 65%, which is similar to its level in other industrialized countries (although in Israel the proportion of those aged 0-15
is higher, and those aged 65 and over is lower than in other Western countries), and is slightly less than it was 20 years ago. During the intervening years, this demographic factor contributed to the growth in the savings rate.
It is reasonable to assume that the dependence ratio will change and increase during the coming decades, due to the ageing of the population as the result of an increased life span and reduced fertility rate. Accordingly and all other conditions being equal, this variable can be expected to lead to a decline in Israel's rate of savings in the long run.
Apart from the age composition variable, which affects savings rates in every country, savings in Israel is affected by the major variable of immigration. During the last six years, nearly 700,000 immigrants, equivalent
to 12% of the total population, arrived in Israel. The rate of savings among the immigrant population during their first years in Israel has definitely been very low, if not negative. As time passes, their rate of savings will increase, and will be most clearly apparent from the repayment of loans granted for the
purchase of apartments.
Pension plans
During the past decade, pensions have become one of the most important financial and economic issues in the industrialized world, including Israel. In contrast to the previously mentioned factors, the effect of pension schemes on the rate of savings is structural in nature.
In most countries, pension funds are managed within the framework of the state budget, and those retiring from the labor market are entitled to a pension determined by law and not by their contributions to a fund. Compulsory pension savings reduces uncertainty regarding the period of retirement from work (especially if it confers
well-defined rights), and thereby has the effect of reducing savings. On the other hand, it forces individuals to save when they would not have done so of their own free will. This form of offset is not total, and it is accepted that
compulsory pension savings increases the rate of national savings. The high rate of savings in Malaysia and Singapore are attributed to those countries'
compulsory saving systems.
Economic literature contains an infinite number of other examples of factors which can affect the rate of savings. Some examples include:
- altruism and egoism
in model of consumption along the life cycle (the more egoistic the bequeathing population, the lower will be the rate of private savings);
- life span (savings increases proportionally to life span);
- the range of savings instruments available to the public, and others.