Question

a. Is there an apparent relationship between low savings ratios and the ratio of foreign debt
to GDP? Explain.
b. Can a nation fund its investments at a level higher than that currently provided by its
income? Explain.
c. What are the probable longer-term implications of this type of behavior?
d. Is a high savings ratio a requirement for funding a high ratio of investment to GDP over
the longer term? Explain.

Answer 1

a. Yes , there is an apparent relationship between low savings ratio and the ratio of foreign debt. It is an inverse relationship , such that low savings ratio in the home country forces the nation to approach external authorities for its financial needs since the internal funds are less or inadequate .

People tend to consume more—the mpc or the marginal propensity to consume is more at lower levels of income so much so that people even dis save or borrow to meet their consumption needs, this in turn has an adverse effect on the savings and availability of funds on an aggregate level—the flow of funds from the household sector and the firms into the capital and money market is low and hence there is a rise in the amount of foreign debt taken to meet various financial needs of various sectors both public (government ) and private (includes firms and households).Low Income leads to low savings lead to low level of capital formation-or investment—this leads to low level of productivity which in turn leads to low level of income which leads to low savings and so on….Hence governments and other economic entities resort to external aid to meet their financial needs. This is an attempt to keep the GDP percentage attest growing though marginally and consistently rather than face a situation of stagnation which could cause major (economic) damage to the economy.

Foreign aid or funding or overseas funding leads to flow of funds to meet various needs , more specifically those which are very important to keep the cycle of growth running smoothly—for example, foreign funds can be made use of to build basic industries, infrastructural development (laying roads and so on.).Sometimes in case of natural disasters also the overseas aid is an important source of finance.As income level increases—rate of growth of GDP, the savings ratio also rises and the available funds from the internal sources to the money market also increases this reduces the need for foreign funds and gradually the ratio of foreign funds to GDP decreases.

b.

Yes a nation can fund its investments at a level higher than that currently provided by its income. An important source of funding is external aid or foreign direct investment. The increasing awareness about ‘open economy’ concept and the growing need to privatize and globalize has effectively opened the path for foreign funds to flow in the form of foreign investments –both direct and portfolio. Direct investments involve investments undertaken by companies (trans national --which have offices all over the world) to buy factors of production like land , labor and so on for investing in other countries. While portfolio investment involves investing in stocks and shares .

Though it is important to attract foreign funds towards the host country. This requires a good socio-political and economic atmosphere.Public investments—made by the government –for developmental purposes are undertaken with a welfare objective. In case the present level of GDP is low for its funding purposes then the governments resort to external sources which would include foreign governments, institutions and individuals. The investment undertaken by such sources is expected increase the rate of growth of the GDP or national income

c. In the long run there would be a significant rise in the real GDP or in simpler terms there would be higher levels of income that would lead to higher levels of consumption and savings. Higher savings would lead to funds being available for investments and capital formation purposes. This would accelerate the growth cycle since the aggregate demand and expenditure would rise—higher income leads to higher saving and higher productivity which in turn leads to higher investments.

However it has to be noted that the external loans are a drain to the economy since the nation has to repay both the loan as well as the interest om the loan and in foreign exchange—or currency of the country that had been the lender of the money. This outflow of the much needed foreign exchange especially in case of less developed nations could cause a financial drain of resources in the long run.

d. In the long run as the income(GDP) rises the proportion of consumption as well as the savings also rises such that there is continuous rise in investment and productive capacity of the economy. The rate on interest acts as a decisive factor for investors to undertake production activities.

Every economy will have its unique ‘growth plan’ where which depends on the savings and investment ratio. Any deviation from such a plan will lead to disequilibrium –or a situation of S > I or I > S, the equilibrium condition therefore lies in S = I situation.

Savings are crucial to investment which leads to capital accumulation which to rise in income and output levels. This rise in output levels leads to rise in employment and income levels, this in turn leads to higher savings which further lead to higher investment. This continuous activity accelerates the rate of growth and keeps it sustaining in the long run.

Current consumption expenditure should be reduced to achieve a rise in the rate of capital accumulation leading to long term growth. An accessible and efficient financial market which can act as an intermediary can help in channelizing the available savings into investments.

          Higher savings can be used for funding a high investment to GDP over a long term only under some condition like the mobilisation capacity of the financial markets to actively channelize the funds (especially the savings of the households) towards productive investment purposes. It also depends upon the entrepreneurial ability of the country’s entrepreneur to undertake the risk and coordinate the various factors of production . It also depends upon the rate of interest. A low rate of interest may dissuade the households from saving in banks and other financial institutions and the households may prefer to save in the form of less liquid assets like buying more lands, gold and so on.