A modified version was published on 21 Oct 2010 (Straits Time)

“Are high household savings always beneficial in Singapore?”

Let’s start by asking why people save. After all, saving has a cost; one could have spent it as saving is income not consumed. So the cost of saving is forgone current consumption. Because most people are impatient, forgoing current consumption is painful and it gets more painful the more one saves.

However, saving also has a benefit; one could invest it and consume more later. But the additional satisfaction from future consumption diminishes the more one consumes in the future. Not surprisingly, there is an optimal saving that balances the cost with the benefit.

Thus, from an individual’s perspective, high saving is not always optimal. Because most prefer to have a smooth pattern of consumption over their lifetime despite their income profiles, they tend to dissave when young or retired, but compensate by saving in between.

Some researchers argue that because delaying “immediate” gratification may be “especially” painful, this generally causes a present bias towards current consumption, resulting in procrastination and undersaving. Presumably this is why we have the CPF.

At a macro level, high household savings may be beneficial to the Singapore economy. First, savings fund investments that expand the nation’s capital stock and productive capacity, making future growth possible. It is worth noting that foreign direct investments have also played an important role in Singapore.

Second, savings (in excess of investments) can be lent to foreigners or used to acquire foreign assets, such as land, factories, stocks, and bonds. This leads to an increase in the nation’s net holding of foreign assets. For individuals as well as for countries, accumulated savings become wealth.

This thriftiness also shows up as current account and trade surpluses, reflecting greater exports over imports.

However, what matters for the Singapore economy is what the nation saves as a whole or national saving, which consists of both private household saving and public sector saving. The two may not be independent. Government budget deficits may cause households to increase private saving if the deficits cause households to worry about their future tax burden.

When the Singapore government runs a budget surplus (when tax revenues exceed government spending), the surplus contributes to public sector saving and becomes the nation’s reserves. For a country with no natural resources, these reserves provide critical insurance against the unexpected. So savings are generally beneficial to the Singapore economy.

Nevertheless, as investments increase and capital stocks expand, successive units of capital stocks become less productive and the marginal contribution to economic growth becomes smaller, in the absence of improvement in total factor productivity. Moreover, forgoing more current consumption to fund more investments may become too painful, and the individuals find it not worthwhile to make the sacrifice. So an optimal saving exists for the Singapore economy as well.

In the extreme case, excessively high savings can hurt the economy. The 1985 recession is an example. For the first time after independence, the Singapore economy experienced an economic contraction. Real GDP growth fell from 8.8% in 1984 to -0.7% in 1985.

No single factor caused the recession. The Economic Committee, chaired by Mr Lee Hsien Loong, identified in its report a combination of external and internal factors as causes, including oversaving in a slow economy.

The CPF contribution rates were at their highest levels: 25% for employer and 25% for employee respectively. The high employer’s contribution raised labor costs, resulting in loss of competitiveness. Gross national saving as a percentage of GNP was 41% in 1985.

This was oversaving because the nation was saving more than it could reinvest productively in the economy and weak external conditions prevented selling overseas what we could not consume or invest domestically.

Nevertheless, the risk of this extreme case recurring is low given what we have learnt and changes made to the CPF.