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In the continuing saga of responses to Noah Smith’s article about the poor and their savings, squarelyrooted chimes in:

Hmmm, I wonder what would happen if everyone started saving as much income as they reasonably could? Where would the high yield investments be with so much capital sloshing around? How would the markets react when aggregate demand plummets even further? – Ethan Gach

 

Snark aside, the key here is that, while it would benefit any individual poor person to save more (assuming, of course, that’s possible given their income and cost-of-living, which is not an assumption I’m eager to make), if every poor person somehow stumbled onto Smith’s article and tried to save more it might generate economic disequlibria that wouldn’t benefit anyone. This is semi-related to the point I’ve made before that aggregate saving is a very different animal than individual saving.

This is just not true. I wish it were true, because it means the poor actually represent a more than insignificant part of our economy. It’s not true for the same reason Noah wrote his article: the poor have no cash savings.

Let’s take a model economy where the top 20% are “rich” and everyone else is “poor”. Let’s be generous and assume the rich control only 80% of the wealth when, in our economy, that figure is far higher. Let’s also stipulate the total value of this economy is a million dollars, and the poor’s aggregate savings grow at 2% per annum against the rich whose grow at 10%. I’ll be conservative and model this with a constant returns on capital across the rich and poor. This obviously isn’t the case, but it doesn’t need to be.

So what we have is 20% of the population controlling $800,000 and the remaining 80% controlling $200,000. At the initial savings rate for the poor, this is what the economy will look like in 10 years:

Year

Poor

Rich

Ratio

1

200000.00

800000.00

0.25

2

214000

920000

0.2326087

3

228980

1058000

0.2164272

4

245009

1216700

0.2013714

5

262159

1399205

0.1873630

6

280510

1609086

0.1743290

7

300146

1850449

0.1622018

8

321156.3

2128016

0.1509182

9

343637.2

2447218

0.1404195

10

367691.8

2814301

0.1306512

11

393430.3

3236446

0.1215624

12

420970.4

3721913

0.1131059

13

450438.3

4280200

0.1052377

14

481969.0

4922230

0.09791680

15

515707

5660565

0.09110519

Now, let’s consider that the poor triple their savings rate to 6%:

 

Year

Poor

Rich

Ratio

1

200000.00

800000.00

0.25

2

222000

920000

0.2413043

3

246420

1058000

0.2329112

4

273526

1216700

0.2248099

5

303614

1399205

0.2169904

6

337012

1609086

0.2094429

7

374083

1850449

0.2021580

8

415232

2128016

0.1951264

9

460908

2447218

0.1883394

10

511607

2814301

0.1817884

11

567884

3236446

0.1754654

12

630351

3721913

0.1693622

13

699690

4280200

0.1634714

14

776656

4922230

0.15778540

15

862088

5660565

0.15229721

I’m not posting a table to vindicate the obvious, but the portion of aggregate savings allocated to the poor will continue to fall until their savings rate is equal to that of the rich, or 10%. This means that it’s highly unlikely that even a significant increase in the savings rate of the bottom 50% (which, in terms of wealth not income, are poor as far as our society is concerned) will cause any “disequilibrium effects”.

Indeed, the ability of the poor to affect our capital markets are even more dispersed in our economy. Because of high levels of risk aversion and poor investment practices, it’s unlikely that they will earn the same rate of return on their savings as the rich. The wealth distribution I assumed is also a lot more equal than what America actually is.

So, contrary to hazy economic thinking, nothing will happen to interest rates and investment markets if we encourage the poor to save. It would be irresponsible to think so because of what Mr. Ethan Gach says. Time to look at the numbers.

Edit: Prof Altman corrects me, log purchasing power was used to facilitate interpretation by keeping constant the % changes across different values of the dependent variable. Although, using log scales seems to be valid regardless to account for diminishing returns to the dollar.

Daniel Altman is out with a new white paper, Are international differences in living standards really so hard to explain? It’s not a long paper, and I’d recommend it to anyone curious about the so-called gap between “the west and the rest”. There’s tons of literature (both general and technical) about international development and the best place, by far, to get a thorough exposure to this material is Development Economics @ MRUniversity. Frequently cited factors include:

  • Institutions (extractive vs inclusive)
  • Geography
  • Natural resources

Niall Ferguson cites six “killer apps”:

  1. Competition
  2. The scientific method
  3. Rule of law via democracy
  4. Modern medicine
  5. Consumer society (“the idea that everyone should have a set of clothes”)
  6. A “Protestant Ethic”

Altman’s paper considers the share of national output that doesn’t come from natural resources like oil or gas. This, arguably, captures the essence of a thriving society: i.e. that which it earned through its culture or institutions (by this logic, it might not make sense to include geography, either, but the results are very interesting). Altman considers three least-squares regressions to understand the portion of economic variance that can be attributed to selected factors. Here are the regressions:

Image

A few quick explanations on the methodology. The log per capita income is used (presumably) to account for the diminishing marginal utility of money. Most of the data is from the 2010 World Bank’s World Development Indicators database though, where 2010 figures aren’t available, Altman considers the 2009 report.

The third regression (which considers gender equality – GII – on top of legal frameworks) is the most appropriate. However, it’s also arguably the most subjective. Perhaps Ferguson would do well to look at this data, which might quell his ancient imperial tendencies, because imperial institutions account for only about 5% of the overall variation in living standards.

But the most striking part of the data is what should be “low-hanging fruit” – landlocked countries. That countries are landlocked is an artifice of false political boundaries dictated in London or Paris and these closed borders, unfortunately, stifle trade and commerce between nations. There’s nothing qualitatively different between a landlocked country and the state of Iowa yet, because of political borders, being landlocked is almost as bad as gender inequality. The curse of these borders is even then understated knowing that this is a binary variable that (should be) easy to fix.

Of course, port cities will always be richer, but only because of the trade industry itself. After landlocked nations get access to international (or even continental) trade, surely economic variance should decline as nations previously excluded from trade prosper.

Indeed, Africa (and, to a lesser extent, Latin America) seem to be the last vestiges of a landlocked era. North American countries are large, each with access to the sea. Australia is an Island. Europe has a customs union. Most of Asia doesn’t live in a landlocked country. Africa is moving towards freer markets in pockets with the East African Community etc. Further, it’s probably not smart to move towards fully free markets immediately. Industrial policy is important in a world of capital, particularly so for Africa to be competitive in the future. However, moves towards regional customs unions so that no nation is locked from trade will be a real boon.

Indeed, it would be interesting to consider a regression that considers not a binary access to seaports, but some index that captures the cost of access to international trade from regulations, tariffs, or any other such policies.

Altman notes that countries with the lowest negative residuals (those that performed worse than expected) were, unsurprisingly, locked in generations of civil conflict, extractive dictators, and war. So comes the cost of having a fancy British legal system.

I wasn’t surprised to see the extent to which Arab countries, like Qatar, exceeded their predicted output considering the ridiculous rents on oil, but was surprised to see that even the United States had a very high residual. Altman points out, this residual can be explained completely by a relatively high GII indicating, perhaps, the subjective nature of the index or, perhaps, a culture that thrives despite gender inequality.

This is an empowering report because about 50% of the variation in output can be reduced to eminently solvable problems (I don’t consider draught to be solvable, though it may be in the future). As development economists have noted for a few years now, Africa isn’t intractable. Jeffrey Sachs noted that almost 30% of economic output can be explained by malaria.

It’s time to get that 30% back.