Explaining National Savings: Formula, Impact, and Importance, and Key Concepts — Penpoin. (2024)

National savings, the total amount saved by households and the government, are the foundation for a country’s economic growth potential. Understanding national savings and how it’s calculated is crucial for grasping how a nation fuels investment, manages its trade balance, and ultimately fosters long-term prosperity. This guide will break down the components of national savings, explore its impact on various economic factors, and explain how to calculate the national savings rate.

National savings are the total amount of money saved within a country, acting as the foundation for its economic growth potential. It represents the sum of private-sector savings and public-sector savings, essentially the total loanable funds provided by the domestic economy. This term is also synonymous with gross national savings or domestic savings.

A high level of national savings indicates a healthy economy with more sources of funds available for investment, particularly from domestic savers. Deeper and more advanced financial markets often accompany this scenario, facilitating the efficient allocation of these savings toward productive investments.

National savings are comprised of two key parts:

• Private savings
• Public savings

Private savings represent the portion of disposable income households have left after paying taxes and fulfilling consumption needs. Think of it as the money left over in people’s wallets after essential expenses are covered. We can also calculate private savings using a different formula (Y-T-C), where Y represents gross domestic product (GDP) or total income, T stands for taxes, and C refers to consumption. Both formulas ultimately arrive at the same concept: the amount of money saved by the private sector.

Public savings, on the other hand, come from the government sector. It’s essentially the difference between tax revenue (T) and government spending (G). When tax revenue exceeds government spending, there’s a fiscal surplus, and the government is considered to be saving. Conversely, if government spending is higher than tax revenue, the situation is called a fiscal deficit, and the public sector is said to be dissavings.

How to calculate national savings

National savings come from two sources the public sector and the private sector. The private sector consists of household savings and business savings.

• National savings = Private savings + Public savings

Public savings come from the government sector. It is positive when tax revenue exceeds government spending. Or, when the government runs a fiscal surplus. And when tax revenues are lower than expenditures, the public sector experiences dissaving.

Private savings

Private savings are the amount of income left after paying taxes and consumption. The formula for private savings is:

• Sp = I + (G – T) + (X – M) …. (equation 1)

In some textbooks, private savings are also written with the equation:

• Sp = Y – T – C … (equation 2)

Where:

• Y = Aggregate income, represented by GDP
• I = Private investment
• G = Government expenditure
• T = Tax revenue
• X = Export
• M = Import

Equation 2 shows private savings are the remaining aggregate income after deducting taxes and consumption. Y-T is national disposable income, i.e., the aggregate income left after deducting tax payments.

Why do we use two equations? Are both the same? And, let’s prove it.

In the income approach, the GDP formula is the same as Y = C + I + G + (X – M). If you substitute Y into equation 2, you will get:

• Sp = Y – T – C = C + I + G + (X – M) – T – C = I + (G – T) + (X – M)

Public savings

Public savings are the amount of tax revenue left after the government finances all its expenditures. Mathematically, we can write it as follows:

• Sg = T – G

If the government runs a fiscal surplus, it means the government is saving. At that time, tax revenue (T) is higher than expenditure (G).

Conversely, when running a fiscal deficit, there are dissavings in the public sector. Tax revenue is lower than government spending. A deficit reduces the total supply of loanable funds.

The final figure: national savings

As a definition, National savings is the sum of private savings and public savings.

• Sn = Sp + Sg = I + (G – T) + (X – M) + T – G = I + (X – M)

From the equation above, you can see, if a country adopts a closed economy (there is no international trade), the value (X – M) is equal to zero. As a result, national savings equal investment.

Furthermore, national savings are useful for:

• Financing domestic investment
• Lend foreigners (net exports)

If the government runs a fiscal deficit (public dissaving), one of the conditions below must occur:

• Private savings must increase
• Domestic investment fall
• Net exports fall

Why the National Savings Rate Matters

The national savings rate acts as a crucial gauge of a country’s domestic financial capacity for economic growth. It essentially measures the proportion of domestic income that’s saved, rather than spent. We calculate this rate by dividing national savings by a nation’s total income, often represented by Gross Domestic Product (GDP).

• National savings rate = National savings / GDP

The formula tells us what proportion of a nation’s total income (GDP) is actually saved. Here’s how:

• National savings rate formula: We calculate it by dividing national savings by GDP. Think of GDP as all the income generated in a country. So, the national savings rate essentially shows what share of that income gets saved.
• Funding domestic investment: National savings act as a pool of funds for domestic investment. Businesses and individuals use these saved resources to invest in new machinery, buildings, or research – all crucial for boosting a country’s productive capacity.
• Low savings rate, foreign reliance: If a nation has a low savings rate, it means a smaller portion of its income is saved domestically. This can lead to a dependence on foreign capital inflows to finance investment. While foreign investment can be beneficial, it also introduces external factors that can impact the economy.
• High savings rate, domestic growth: Conversely, a high national savings rate indicates a larger pool of domestic funds available for investment. This allows the country to finance its own growth without relying heavily on foreign capital, potentially leading to more stable and sustainable economic development.

In a nutshell, the national savings rate reflects a country’s ability to generate its own investment fuel and drive long-term economic growth from within.

Savings equals investment

The national savings rate, calculated by dividing national savings by GDP, measures the portion of a nation’s income saved for future investment. A high savings rate indicates a larger pool of domestic funds available for businesses and individuals to invest in new machinery, buildings, or research. This ultimately boosts a country’s productive capacity and fosters long-term economic growth. Conversely, a low savings rate can lead to dependence on foreign capital inflows, potentially introducing external economic factors.

• National saving rate = National savings / GDP

Imagine you save $100 and buy a company’s bond to earn interest. The company uses the money you invest to buy new equipment. In this simplified scenario, your savings directly fund the company’s investment.

It’s important to remember that this applies to the economy in the aggregate, not necessarily to every individual or company. Additionally, in an open economy with international trade, savings might flow abroad for investment opportunities, and investment might be financed by foreign capital inflows.

Government spending and national savings

If the government runs a fiscal deficit, public savings are negative, and national savings decrease, thereby reducing the supply of loanable funds in the economy.

Because interest rates represent prices for borrowing money, a decrease in the supply of funds will drive up interest rates in the economy.

Higher interest rates make borrowing costs more expensive, which affects the private sector’s willingness to borrow. An increase in interest rates causes fewer families to buy new homes and fewer companies to purchase new capital equipment.

As a result, the fiscal deficit causes a decrease in business investment and household consumption. Economists call this phenomenon the “crowding out effect.” It can reduce the rate of economic growth if household consumption and business investment are more significant than government spending.

National savings and the trade balance

Before discussing it again, let’s take the national savings formula above:

• Sn = I + (X – M)

If national savings exceed domestic investment (Sn> I), there is an excess supply of loanable funds. Domestic money will flow abroad, for example, by investing in other countries’ sovereign bonds. Net exports will increase.

Conversely, when National savings is lower than domestic investment (Sn <I), net exports will decrease. The domestic economy must borrow from abroad to finance investment (through capital inflow).

When a country experiences a trade deficit (M > X), it can occur because domestic savings are inadequate to finance domestic investment (Sn < I). Or, it happened because of the government’s fiscal deficit.

For example, if the national savings is $1,000 and domestic investment is $2,000, then net exports will be equal to $1,000 (trade deficit).

Say, private sector savings are $3,000 and domestic investment is $600. Hence, the government budget deficit will equal:

• Sp + Sg = I + (X – M)
• $3,000 + Sg = $2,000 – $1,000
• Sg = – $2,000