Saving behavior in low and middle income developing countries

Munich Personal RePEc Archive

Saving behavior in low- and

middle-income developing countries

Reinhart, Carmen and Ogaki, Masao and Ostry, Jonathan

University of Maryland, College Park, Department of Economics

January 1995

Online at

https://mpra.ub.uni-muenchen.de/13757/

IMF

PAPER

O 1995 International Monetary Fund

Thii is a Wking Paper and the authw(s) wMJd &me

any commEntJ on the p a n t wxc. Citatbm Jhwkl mkr a Working Pqxr 06 he International M o n e w Fund. mm cioning the aufhw(s), and the date of isauanoe. 'lhc &M

ex+ arc those of the author(s) and do not n c u s a d y

rc-nt those of the Fund.

WP/95/3

INTERNATIONAL MONETARY FIMD

Research

Saving Behavior in Low- and

Middle-Income

Developing

Countries:

A

Prepared

by

D.

Carmen

M.

l

J

Author

f

for

distribution

by

Peter

Wickham

Abstract

The impact

o f

in

a central issue

in

According

one familiar view,

financial liberalization

which

real

should

boosting

growth.

While

liberalizations

have

in raising

interest rates,

their

on

saving

has

This

paper uses macroeconomic data

for

of

with

income levels

in which

with

are

then

in

of

of

countries

differing

of development.

3EL

Class1

f

Numbers:

F41,

I

J

of

Ohlo

University; Ostry

Reinhart: Research Department, International Monetary

Fund.

expxessed

in

attributed to the institutions

with

which

are

affiliated.

The

wish

thank

the

Ohio

University,

well

Miguel

Peter

Wickham

for

f o x

excellent

research

-

Ti

-

Contents

Summary

I .

31. S t y l i z e d Facts

111. Analytical Framework

IT.

Empirical Results

1.

2. Empirical methodology and estimation results

a. The

f i r s t

e l a s t i c i t y

of

b. The second s t e p : estimating the intertemporal

parameters

V . Saving and the Rate

of

1. A simple model of endogenous growth 2 . Results

V I

.

Text

1.

Percent of

Personal Expenditure for

2 . Personal Saving Rates for S e l e c t e d Countries

3 . Canonical Cointegrating Regression Results

4 . The intertemporal Parameters: Generalized Method of

Moments Results

5.

The

and L o w e r Middle-fncoms Countries

6.

Lower

Middle-Income Countries

Chart

1.

The

Substitution

u

iii

The

in

key

in the

of

number o f

and

policy-induced shocks in

typically

real

in

the

growth--have been much less clear-cut.

In

current

changes

domestic interest rates depend

on

the

private

Finally,

of

or

ccmsumption rates of interest (which measure the true cost of consuming today relative to consuming tomorrow)

in

the

of

which on

the

critically on

the

of

real

Empirical evidence suggests t h a t the intertemporal elasticEty

of

substitution in consumption

(on

considerably

developing

This

argues

that a main reason for t h i s variation

may

be

country's

of

development. Specifically, because

of

role of

in

e x h i b i t a n e g l i g i b l e response

of

in

subsistence needs have been met increases. As only this fraction of the budget is sensitive to movements

in raal

nonlinear

of

and the

level

The

of

therefore

be

in middle-income

than

in

(where it will be close to

zero),

but

be only slightly

in

high-income

than

in

middle-income

role

in

These notions f i n d support in the data. Using macroeconomic data from

a sample of countries w i t h diverse income levels, the paper concludes that a

model in

trhich the

is an

increasing

function

of

the

income

the

level cannot be rejected. The model implies v e r y

different

of

private savfng to (exogenous and policy-induced) raal interest rate

shocks,

I.

The

in

and economic growth, is a central issue

in

familiar

Shaw (1973)),

an

should

encourage

of

available

domestic investors, thereby enabling the economy to grow more quickly.

Indeed, a

number

had

to increase i n t e r e s t rates from levels t h a t in many cases

were

in

While

in real

have

been

such

liberalization

for

Calbis (1993)), their impact

on

has

unclear. L/

There

in

on

the

interaction between saving and the real rate of interest ( s e e , for

instance, Savastano

(1994)

Schmidt-Hebbel,

review

a £ this literature). Some researchers have been unable to d e t e c t much of

an effect of changes in real interest rates on domestic saving in

developing counrries

.

only

five

developing

in

and saving sensitive to changes

in

He

t h a t f o r

the

"the

of

real rate of

from

215)

one

saving to the real rate of interest [in developing countries]" (page

197).

in

of

likely to

in

in

developing countries" (page 104).

In

single

good, O s t r y and Reinhart ( 1 9 9 2 ) confirm these

findings;

goods is assumed, these authors f i n d higher and statistically significant

estimates of t h e intertemporal e l a s t i c i t y of substitution. However,

regional differences emerge, with

Asian

responsiveness to real interest rate changes. 2J

The finding

of

in a

number

hypotheses

result.

hypothesis is that consumption

in

may

more

in

4/

For

running

contrary

the

McKinnon-Shaw hypothesis,

Buffie

(1982)

(1983).

experience with

financial

2/

Reinhart 11992)

differences

countries--than to intertemporal consumption smoothing.

J

I

If

must:

considerations g u i d e their decisions

only

that

left

then

close to zero for countries at or near subsistence consumption Levels, and

rising

A second reason why the intertemporal elasticity of substitution

may

be smaller

for

share

of

n e c e s s i t i e s

in

of

households. If

(for

through

then the intertemporal e l a s t i c i t y of substitution will be lower

for

where such

less

be

that

for

where

relatively

saving

be

low. 2J

It is indeed noteworthy that food consumption accounts for a markedly

lower share of total expenditure

in

than in low income

countries. As

shown in

Table 1,

twenty percent of t o t a l expenditure in most industrial countries and for only 8 percent of t o t a l consumption in the United S t a t e s .

For

countries such as Mexico and Thailand,

the

while for t h e poorer countries the share of food approaches 60-70 percent ( s e e Mitchell and lngco (1993)).

Empirical

for

hypotheses

found

Atkeson

Ogaki

(1993).

they find

six households in their data s e t is approximately 1.6 times that of the

poorest six households.

Thus,

their

o f

the

of

on

intertemporal

of

appear to be economically significant.

h/ For

the

role played by

in

On the b a s i s of a similar argument, Rebelo (3992) argues that

financial

liberalization in

produce large e f f e c t s

on

the

of financial

i n

Galbis (1993). For an analysis that highlights

stylized

the differences in saving behavior between l o w - and middle-income developing countries, see two recent World Bank

volumes

dealing respectively w i t h the performance

of

the

of

Table 1.

Food

as

a

Percent of Total Personal

Expenditure for Selected Countries

Country

Percent

Law-Income Countntnes

India

Sierra

Leone

Lanka

Sudan

Average

for

Qrmp

Lower

Middle-Inmmc

Caunr'es

Colombia

Ecuador

Fiji Jamaim Jordan Philippints Thailand

Average for Group

Up- Middle-

I n m e

Coun

Greece

Malaysia

Mexico

South

Amca

Venezuela

Average

for

aroup

High

-Income

Canada

Belgium

Sweden

United

Kingdom

United State Average

for Orwp

Note:

For chsifiation

of

cconomfm

Income

I&

see

World

Bank

There a r e , however, additional reasons

why

responsive to changes

in

incame countries. Rossi (19881, for example, argued that low-income

developing countries are characterized

by

liquidity

which

imply

in

likely

f o l l o w

income

in

of

J

l

empirical evidence appears t o point to the presence of liquidity

constraints in many developing countries; however, Haque and Montiel (1989) highlight t h a t the severity of these constraints varies considerably across

countries.

More

that the

inversely

economic development

which

imply--following

in poorer countries should be less responsive to interest rate changes. 2J

Lastly,

argued

relationship bemeen

saving and

and across time may a l s o be due to considerable variation in

the

the

Lack of sophistication and depth in domestic financial markets or direct

regulation may result

in

In

addition, lack of information

on

for

high-inflation

While a number of hypotheses have been put forward to suggest t h a t

saving behavior in developing countries is a f f e c t e d by the Level of

development, there

has

of

this

the

Yet

policy perspective, the issue is of

central

the e f f e c t s on--inter

alia

actions frequently undertaken by developing countries--including financial

liberalizarion, reducing capital controls, and the transmission of fiscal

and commercial policy

changes

current

all be governed

l

J

has

constraints in explaining consumption/saving behavior in developing

countries.

2

J Vaidyanathan (1993)

also

that

financial liberalization

in

developing

the

Although no direct t e s t s were undertaken,

the

would be

that

financial liberalization, by

the

of

which

liquidity constraints are

binding,

sensitivity

of

saving.

to some degree by t h e responsiveness o f saving to i n t e r e s t rate

changes.

l

J

With this in mind, the purpose of this paper is to q u a n t i f y empirically

t h e response of c o n s ~ p t i o n / s a v i n g t o

changes in

real

W e proceed

in t w o

countries with diverse income levels to estimate a

model

allows

intertemporal elasticity of substitution to vary with the level of wealth. W e then use

the

in

simple endogenous

growth

of saving

with

The remainder of the paper is organized as follows. Section

I1

presents some s t y l i z e d facts on saving behavior and income levels and

focuses

on

the

analytical

while

IV

empirical

estimation results. The response of saving to changes

in

in

in

the

final

11. Stylized Facts

A model, such as the one developed

in

this paper,

behavior, First, saving rates should increase with the level

of

the

in

I;/

terms of trade disturbance, through its effect on the consumption r a t e of

i n t e r e s t , depends

crucially on

saving to

Razin

(1983)

Ostry

(1988)).

In

liberalizarions will also generate changes in consumption rates of

i n t e r e s t as

households

in

for

Razin

and Svensson (19831, Calvo (1987, 1988,

1989)'

induce a consumptian boom (and a current account deterioration) therefore depends

on

The

this

is

in

number of

may

rationalize the empirical

findings

(1992)

that

have little systematic effects an saving and current account behavior.

Finally,

in domestic interest rates) to

the

will be governed

by

the

rate occurring as a country moves f r o m

low-

J

Second,

in

real

from

in t h e

the

in

consumption declines

with

2/

be r e l a t e d to subsistence considerations, since intertemporal incentives should

only

that

has been achieved, t h a t i s , discretionary income.

With regard to saving rates, a model t h a t stresses the role of

liquidity constraints offers a different p r e d i c t i o n ;

if

income

the

precautionary saving rises ( s e e , f o r instance, Deaton (1989)).

Hence, it may be the poorest lfquidity-constrained consumers t h a t save

more. However, as w i t h

the

saving to changes in interest rates rises with the level of wealth as

liquidity constraints become less binding.

Among countries in various income groups,

the

rates that emerge are broadly consistent w i t h

the

subsistence model. As Table 2

highlights

for

the

developing countries,

where

half

the high-income group.

4J

regions. According to the World Bank {1994a), median gross domestic saving as a percentage of GDP

(1987-91

the low income African countries and 19.0 percent f o r the middle-income African countries (the average was 7.7 percent).

As predicted, t h e

relationship

level of

saving r a t e appears to be nonlinear

for

Rebelo (1992)); the largest increases

in

transition from low- to lower middle-income, where the average personal

saving rate rises by 5.5 percent (Table 2 ) . The average f o r the upper middle-income countries is s t i l l 2 . 8 percent above t h a t of the lower

middle-income group,

but

difference

(0.5

the

in

the

income and upper middle-income countries

in our

- -.

1/

savLng rate need n o t increase

in

high

levels.

2J S e e , f o r example Barro (1990) and Rebelo (1992).

This

constraints, is empirically investigated

in

(1994).

Table

2.

Personal Saving

Rates

for

Selected Countries

(lW-I1)9J a * e n g n . ~ ~ e ~ n ~ d )

-

ia 1915

s

T V i 6395 -Ilf

Ehrkwa R& W6 111

8882 135

h h d r g m r 9168 4 3

TOP %SF9 14.0

! h d i a 1144.4 62

Ghana 1161.1 6.1

H& 1210.4 4 5

1 197.9 1 8 2

S w m h 1311.0 8.1

N- l W J 95

P 8 k a u 1m 230

Lm5*

3m.o 143

S r i h h 2156.1 1 98

Rdik m79 322

-8- 3576 127

-

El* ZZMD 15.0

p b i i p p e 8 ' 2- 162

~d

M i mReplib B11.1 118

Tbrihd m1.4 pa

3LI&tl 146

3773.4 145

Peru 3B65 244

k*

3%25

m

U t h 4lM.O I 2 7

PdradY 43W.6 2&S

CWe 4ST7F87d 1 2 8

Still, there appear to be sharp differences in savings rates t h a t

cannot be accounted

for

by the

For

saving

rates in L a t i n

America

are

well below

in many

countries, despite similar income levels.

J

l

Bank

in

1990;

high

an

The role o f

real

in saving

more

t o gauge. One

problem--which

in Africa,

that

financial

in

Bank

study on Africa (World Bank ( 1 9 9 4 a ) ) , "most countries

[in Africa] have

few banks, and

...

114).

This

in low-

income countries may i t s e l f make saving less responsive to interest rates

Nevertheless, there is some evidence t h a t financial savings increased

as a resulr o f the increase in real interest rates associated with

l i b e r a l i z a t i o n of financial markets, b o t h in Africa and elsewhere among

developing countries.

For

in

China

1949

in

by

Chile,

(see Uorld Bank (1993) and the references therein). There is also some

evidence t h a t r e f o r m programs

in

in

savings, For example, as documented in World Bank (1994a), median gross

domestic saving

climbed

for

w i t h a large improvement in macroeconomic p o l i c i e s (whlch consisted

of

indicators,

of which

rate

policy),

d e c l i n e

of

for

w i t h

In

moving

rates

sharply

positive

levels

in

savings, although there is no particular evidence

that

of such policies rises with the level of development, as

the

model would suggest.

An

of this

in

following three sections.

U

an

independent influence an saving behavior, but w e are unaware of any

111.

Analvtical

We begin by describing the maximization problem faced by a

representative household in a given country. Since our ultimate purpose is to examine cross-country differences in saving behavior, we do n o t

assume that representative hauseholds

in

identical preferences. As in Ostry

and

framework that distinguishes between traded and nontraded goods. As argued

in

that

subsritution

with

when

p r i c e

of

real

considerably through t i m e , as we will discuss later. W e allow

for

between traded and nontraded goods and t h e intertemporal elasticity of

substitution.

The

is

that

the level

of

by

in

(1)-(7)

Consider

then

an infinitely-lived

household whose objective is to choose a c o n s ~ t i o n stream t h a t maximizes:

subject t a the series

of

and the transversality condition:

where Q is the expectations operacor conditional on information available

at time 0 ; Bt denotes the real level of debt carried from period t to period

t+l w i t h Bdl given; (

1 ) -

r

real

of the numeraire)

on

the

R;

factor; m (n) denotes consumption of importables (nontradables) and p (q)

denoted the r e l a t i v e p r i c e of

m

(n)

of

p

subjective discount factor; and E

(PI

(intertemporal) elasticity of substitution.

I

J

elasticity oaf subsritution greater (less) t h a n one implies gross

substitutability ( c o m p l e m e n t a r i q ) between traded and nontraded goods;

a value of

unity

intertemporal elasticity

of

the

of

consumption (and therefore saving) t o changes in intertemporal p r i c e s ( i . e . the consumption rates of i n t e r e s t ) ,

with

greater sensitivity.

The problem of the representative

consumer in

given

an

I%,

that

(1)

and ( 3 ) . The first order necessary conditions

for

Equation (4) is the intertemporal

Euler

in

cost

of

one unit of

analogous condition relating the marginal rate of substitution between

consumption

of

n

rhe relevant

relative

equating

the

marginal

of

importables and nontradables to the corresponding relative price ratio.

It can be verified t h a t equations (4)-(6) are net kdependent.

Specifically,

remaining

the

third.

Therefore, given

that

first

independent restrictions on the evolution a£ consumption through time.

l

J

in

The main difference between

the

model

Euler-equation models t h a t

have

countries (far example, Giovannini (1985) and Rossi (1988)) relates to the goods structure.

In

t r a d a b l e s and nontradables s i n c e the latter appear to account for a large

fraction of the consumption

basket

in

imposing a one good structure can seriously bias the resulting estimates of preference parameters,

If

of traded and nontraded goods) varies over time, as is the case

in

developed and developing countries, aggregate consumption

will

those price changes. This is because a change in the real exchange rate

alters the consumption rate of interest. As

such channels

are

ignored

in

may

b i a s e d .

J

l

the

finding

that

of

substitution are insignificantly different

from zero in

robust to a relaxation of

the

Given time series d a t a on importables and nontradables consumption,

and on interest rates,

and

p o s s i b l e to estimate the system consisting o f ( 4 ) - ( 6 ) and recover the main parameters o f interest.

Since

(6) must

identically

(in the

of measurement e r r o r ) , and since (&) and ( 5 ) are not independent given t h a t (6) h o l d s , we can eliminate ( 6 )

or

restrictions on the j o i n t behavior of consumption of importables and

nontradables, the terms

of

the

by the maximization of the expected utility function given by (1) s u b j e c t to the constraints given in ( 2 ) and

( 3 1 ,

In addition, given the assumption

of

equation (&) to define the disturbance :

where

q

be

with

any

in

set

of

With

in

country

fully

how

parameters governing saving behavior vary systematically across countries.

In what follows, we rake a particularly simple approach motivated

by

Stone-Geary

by

l

e l a s t i c i t y

of

an

the

viz:

where pi denotes

the

i;

P

r e f l e c t s subsistence consumption.

Clearly,

Stone-Geary preference s p e c i f i c a t i o n but w i t h permanent income replacing consumption. Conceptually, we focus on income rather than consumption

in

e l a s t i c i t y of substitution and the level of development (i.e., income per

c a p i t a ) . Equation (8) shows t h a t the interest-rate s e n s i t i v i q of aggregate

consumption ( a s well as the level

of

the

ratio, 7/y;1, approaches unity and wealth is only sufficient to support a subsistence level

of

fV.

Results

1.

The parameters of the representative

household's

outlined

in

The

Egypt, Ghana, India, Pakistan, and S r i

Lanka;

countries consist of Colombia, Costa Rica, C b t e drIvoire, Morocco, and the

Philippines;

the

analysis:

Brazil,

country

in

As equations ( 7 ) and ( 8 ) h i g h l i g h t , estimation of the intertemporal and intratemporal elasticities of substitution requires data on household

consumption of traded and nontraded goods,

the

While

readily

available,

traded and nontraded goods and estimates

of

regard to

the

d e s c r i b e d in detail in Ostry and Reinhart (1992). B a s i c a l l y , we assume

that

the

private services while traded goods production emanates f r o m the

agriculture,

can

then

be

en

and i m p o s t s

of

calculated residually as total private consumption less consumption of

importables. The relevant price deflators f o r

the

and nontraded goods are price indices

for

the absence of these, a

money

was

Finally,

of

for the period 1980-87 w a s used.

U

2 . E m ~ i r i c a l methodolow and estimation results

In this subsection, w e apply Cooley and Ogaki's

(1991)

the

substitution between t r a d e d and nontxaded goods and f o r the intertemporal

elasticity of substitution. A similar procedure, which was applied

independently

by Ostry

(19921,

to obtain first-stage estimates of the intratemporal parameter

and

Generalized

(GMM)

of

a. The first step: estimating the intratemporal elasticirv of substitution

Many

be

difference

.

Under

of

and deterministic cointegration are useful in

examining the

between t w o or more variables of interest. J2 Suppose that the

components of a vector series X ( t 3 are 1(1) p r o c e s s e s w i t h d r i f t ;

if

an

eliminptes the deterministic trends as

well

the

that h X ( t ) is stationarv.

This

Standard unit root t e s t s suggest t h a t it is reasonable ta model the

relative price of traded

and

the

(of nontraded to traded goods) as

I(1)

on

The

of

the relative

log of the consumption r a t i o are cointegrated with the deterministic

I

+

/

Stochastic cointegration and the deterministic cointegration

restrictions were defined by Ogaki and Park (1989) and Campbell and

Perron

(1991).

gains

by imposing

by

West (1989) f o r the one-regressor case and

by

for

cointegration restriction.

1/

_If

consistent estimate of the intratemporal e l a s t i c i t y of substitution, E . 2J

To test for cointegration, we employ

Park's

Canonical

Regression (CCR) procedure. 3J

There are several advantages associated with

CCR.

parameters, a and E in t h i s case, are not

only

OLS),

the

and normal conditioned on the regressors. This Latter feature a l l o w s

for

of the

far

hypothesis

Carlo

Park

Ogaki

(1991)), CCR

small

Johansen's estimators.

This

CCR

attractive for the present application, where

the

the

sample size is limited.

R~arranging terms, taking logs. and introducing a disturbance term (to allow,

for

Equation (9) is

likely to

from

prices are determined endogenously, and the

error

may

correlated.

4/

for

the

such nuisance

parameters,

long-run

data, As shown in Park (19921, the transformed data w i l l be cointegrated

with the same parameter vector as fhe original data.

Under the

null of

the CCR

that

by

ZJ

These

x2

with

trends

to test

for

For

t h i s

the CCR procedure is a p p l i e d to a regression

As shown

by

(1978),

random

walk when the

real

interest rate is assumed to be constant. Since we allow

the

This will a l s o y i e l d a point estimate f o r the parameter a,

which

related to the consumption

share.

See Ogaki (1993a) f o r a more d e t a i l e d explanation

of

e s t b a t i o n and testing.

Note that the OLS estimator is consistent b u t

n o t

long-run

L e t H ( p , q ) denote the standard

Wald

hypothesis

tj + ~ = q p + 2 = . . . ~

=0,

I+

q

of the long r u n covariance matrix ( s e e Park (1990)). Under the null of a

cointegration H(p, q ) converges to a x L In particular, the H(0,l) 4 - P '

s t a t i s t i c t e s t s the deterministic cointegrating restriction,

which

suggested

by

first

the

H[l,q)

Table 3 reports the CCR resulss.

I

J

shown in

(13,

the exception of Korea, the intratemporal elasticity o f substitution,

r ,

is estimated to be positive, consistent w i t h our theoretical priors. Tn

the case of Korea, where t h e estimate of E is significantly negative, the

H(0,l)

column

the

specification,

implied by

the

possible that

the

by

in

this

countries, the point estimates f o r E range from a l o w

of

2.16;

substitution exceeds unity, implying gross substitutability between traded

and nontraded goods. For the Philippines, the p o i n t estimate of E is

positive but is n o t significantly s o , and the

H(0,l)

rejected (columns ( 3 )

and

levels.

other countries, none

of

1

chem

are

level,

null

cannot be rejected.

.- -. - - - - -

We

Ogaki's (1993b) GAUSS CCR

the

CCR

The

CCR

long-run

of

disturbances

i n

the

system.

Park

Ogaki's

(1991)

w i t h

Andrews and Monahan's (1992) prewhitened

HAC

kernel.

VAR

followed Andrews

Monahan (1992)

with

notation) was set to 0.99.

h d r e w s ' s

fitting an

AR(1)

21

(1993),

an

-

nonhamothetic preferences w i t h an extended addilog utility function. These

authors assume time

separability

of

in

T a b l e 3 . Canonical Cointegrating Regression Results

Country

Brazil

Colombia 0.678 5.363 0.687 0.836

(0.214) (0.021) ( 0 . 4 0 7 ) ( 0 . 6 5 8 )

C o s t a Rica 1.132 0.474 1.087

1.934

(0.179)

Mexico

Sri Lanka 1.587 0.669 0 . 6 7 4 1 . 7 3 7

(0.157) (0.414) (0

-419)

India

Korea

Pakistan 2.075 0.558 2 . 2 5 6 3.942

(0.267)

Philippines 0.382 7 . 9 8 9 0 . 6 9 5 2.040

( 0 . 3 3 3 ) (0.005

>

Ghana

Morocco

U.S.A.