Effect of Savings on GDP - Essay Example

Saving Effect on GDP Introduction GDP is the total market value of all final goods and services produced in a country in a given financial year, equal to total consumer investment and government spending, plus the value of exports, minus the value of imports (GDP). GDP often considered as the symbol of standard of living in a country even though many economists have different opinions. Savings on the other hand is an income received by a consumer that that is not spent on the output of firms through consumption expenditure (RELATIONSHIP BETWEEN GDP, CONSUMPTION, SAVINGS AND INVESTMENT, p.1). Savings even though considered generally as a good habit especially like the current periods like recession, many economic Gurus are of the view that too much savings can adversely affect the economic growth. Savings and GDP growth have direct relationships. This paper briefly explains the relationships between savings and GDP growth, production factor and savings ratios and the effect of too much savings on economic growth. Savings and GDP growth of a country Income = Consumption + Savings The largest part of total spending is consumption (RELATIONSHIP BETWEEN GDP, CONSUMPTION, SAVINGS AND INVESTMENT, p.1). GDP can be calculated using the formula Y = C + I + E + G where Y = GDP, C = Consumer Spending, I = Investment made by industry, E = Excess of Exports over Imports, G = Government Spending (Calculating GDP). From the above two equations, it is clear that when the savings increases, income will also increase and the increase in domestic income can result in increase in GDP. Income is utilized in two ways; consumption and savings. If the consumption is less, savings will be increased whereas if the savings are less, consumption will go high if the economy is stable. On the other hand, if the economy is weak people may not have enough resources and they will be forced to spend less and it is not necessary that savings may go up in this case because of less spending. In most of the cases, people forced to spent major part of their income to consume goods. It is impossible for the public to save much and spent less because of the increasing expenses and living standards. (Comments on GDP and Savings Rate) From the graph given above and below it is clear that GDP has come down a lot because of the less personal expenditure. The 2008 global financial crisis has occurred at an unexpected time and many people lost their jobs and forced to cut down their personal expenditure. In fact people cut down their expenditure to save money for the future. At the same time this cutting down of expenditure has resulted in fewer demands for the goods and the fewer demands forced the manufacturers to produce less. In short, the domestic production has come down a lot because of recession and less demand which forced the GDP to come down drastically. (Comments on GDP and Savings Rate) Do production factors affect changes in saving ratios? Why? The savings ratio is the level of people’s savings as a percentage of their disposable income (Tutor2u). The savings ratio will become high when the people have enough money in their hand. Unemployment and high interest rates can increase the savings ratio. On the other hand, in recent years savings ratio has come down drastically because of higher levels of consumer borrowings. Production factors depend on demand of goods in the market. If the demand for a good is more in the market, manufacturers will normally increase the production. On the other hand, if the demand becomes less, the manufacturers will be forced to reduce their production. Demand depends on the financial abilities of the consumers. If the consumers have money in their pocket, they will usually spend much whereas less money means less spending for consumers. For example, the current recession forced the consumers to spend less and hence many of the manufacturers forced to reduce their production. The key factors that determine consumer spending in an economy are The level of real disposable household income Interest rates and the availability of credit Consumer confidence Changes in household financial wealth Changes in employment and unemployment (Tutor2u). Unemployment, high interest rates and weaker economy may force the consumers to spend less. Consumers are always reacting as per the fluctuations in the economy and market. For example, India is a country which is rapidly developing. Even the current financial crisis has not affected Indian economy much even though countries like US and UK struggled to come out from the crisis. The adversely affected countries and their people forced to limit their spending on consumer goods whereas people of India and China like countries have not reduced their spending habits much. In fact many of the MNC’s all over the world are now establishing their manufacturing units in India and China like countries. For example, Toyota, Hyundai, Mitsubishi, BMW like big automobile companies already established their plants in India. In short, economic abilities of a country will reflect in its people’s living standards. Economy and too much savings In my opinion, too much saving is not good for the economic development. Economic development is directly related to the economic activities in a country. When the savings increases, consumer spending will decrease. Less consumer spending means less demand for goods and less production. No manufacturer will be able to produce more when the demand becomes less. Manufacturers can produce more only when the produced goods move well in the market. For example, consider the tire industry. If the demand for vehicle becomes less, the demand for the tire will also become less. The less demand may force the tire manufacturers to reduce their manufacturing operation. Rubber is an essential component for making tire. The reduced activities in tire manufacturing may result in less demand for rubber and the rubber growers may suffer major set backs because less demand may reduce the price of the rubber they produced. Noted economist and Nobel Prize winner, Paul Krugman is of the opinion that the consumer spending should be increased in order to come out from the current economic crisis. In his opinion, no need to bother about the official rate, because you really should count all those capital gains on houses and stocks (Krugman). In his opinion, if there were a shortage of savings, the economy wouldn’t be depressed. He has also defined recession in terms of savings. He has argued that recession is all about a decline in a certain type of "savings" in which money printing by the Fed enters the savings sector and causes funds to be added to investment portion of the economy. It is this type of "savings" that is in decline when the Fed slows money printing that causes the recession (Krugman Disses Savings) Thus it is evident that too much savings is not good for economic growth. Money needs to be for spending, not for savings. Money gets its value only when we spend it. Other wise it has only the paper value. For example consider a person keeps millions of pounds with him and not investing it any where. That money has only paper value and, if that money gets damaged somehow, he will suffer major loss. On the other hand if he invests that money either in financial market or in properties, he will get returns and that money can be utilized for economic progress of the country. The real value of the money can be obtained only when we spend it. Conclusions Savings has direct relationships with GDP growth and economic progress. Savings up to certain limit can boost the GDP growth whereas too much savings can adversely affect the economic growth of a country. Economic growth and GDP growth are related to the consumer spending and domestic production. Production will increase only when the consumer demand increases and in order to increase the demand consumers should be actively involved in the market activities. Consumers staying away from the market are not a desirable condition either for the Gross Domestic Product Growth or for the economic development. Production factors can affect the savings ratio. The savings ratio will become high when the people have enough money in their hand and the saving ratio will become less when the consumer borrowings increases. Many people have the false belief that they should spend less to come out from the economic crisis. But such habits can worsen the problem. Increased consumer spending is the only way to increase the economic activities which is needed for the economic progress of a country. Works Cited 1. “Calculating GDP”. 15 March 2010. 2. “Comments on GDP and Savings Rate”. 15 March 2010. 3. “GDP”. 15 March 2010. 4. Krugman, Paul.2010. “No Savings Grace”. The New York Times. 15 March 2010. 5. “Krugman Disses Savings”. 2009. 15 March 2010. 6. “RELATIONSHIP BETWEEN GDP, CONSUMPTION, SAVINGS AND INVESTMENT”. 15 March 2010. 7. Tutor2u. “AS Macroeconomics / International Economy”. 15 March 2010. Read More