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March 18, 2012, Sunday

The worrying savings gap

Ever since the current account deficit (CAD) climbed to its historic record high of 10 percent of gross domestic product (GDP), Turkish economic circles have started to intensely discuss the savings gap and its collateral -- the unsatisfying appetite for consumption. In this regard the most recent example was Prime Minister Recep Tayyip Erdoğan's stigmatization of Turkish citizen's appetite for new mobile phones and big cars. It is well known that CAD corresponds to the difference between investments and domestic savings, called the “savings gap.” Also, it is well understood that Turkey cannot sustain such a huge CAD since it is financed by foreign savings. So, the solution seems very simple: Increase your domestic savings if you want to decrease your CAD.

It is easy to say but very difficult to do. The savings behavior of economic agents is one of the last remaining mysteries in economic theory. We have, of course, some ideas about saving motivations, but we are still unable to explain fully, for example, why the Chinese, who are as poor as Turks, save a much larger share of their income compared to Turks. The level of the welfare state as well as cultural differences give some rough ideas about this mystery but do not help us that much to design effective and politically feasible policies. Anyway, my concern in this article is not China but Turkey. What we have to know to start is that domestic savings declined dramatically in the 2000s. From more than 20 percent in the 1990s, the domestic savings ratio decreased to less than 13 percent in 2011. But the Turkish economy continued to grow and to invest more than 20 percent of its GDP, which explains the CAD explosion.

Public, corporate and households make up domestic savings. Public savings jumped from deficit to a limited surplus (around 2-3 percent of GDP) during the 2000s thanks to the fiscal discipline pursued by successive Justice and Development Party (AK Party) governments. However, this effort has been a little bit relaxed in recent years. So, there exists some room to increase public savings, maybe by another 1-2 percent; however, according to a World Bank report published last week, this requires more tax receipts from income, thus less tax evasion. But this would not be enough. You have to invest the extra income instead of spending it on social welfare programs. This is easy to say but difficult to do for an elected government.

Regarding private savings, let me remind you that we do not know how they are shared between corporations and households. Astonishing, but true! We suspect that the appetite for consumption of households is responsible for the dramatic decline of domestic savings, but that is it. Before asking how households can be encouraged or obliged to save more, let me ask if Turkish corporations can save more. Yes, they can if profits increase and if these profits are invested instead of distributed to shareholders. The straightforward way to increase profits would be via wage deflation, but this can hardly be done under a democratic regime. Research points out another way, a depreciation of the national currency. But given the continuing fight against inflation and the flexible exchange rate regime, there are limits to the depreciation of the Turkish lira. Indeed, the effective solution would be an increase in worker productivity. This is possible, of course, but only in the long run and if comprehensive productivity-enhancing reforms in education, technology, innovation, market competition and so on are realized.

To raise domestic savings the key agent is obviously households. Why did they increase their consumption in the 2000s? As pointed out by the World Bank report, it is because they have been better able to access bank loans due to the greater availability of international liquidity; they did not want to miss the occasion offered by the falling interest rates, thanks to tight fiscal policy, and there are now fewer worries about unexpected health expenses thanks to improved and extended social coverage by the state. Good! But these findings do not help us to design a policy to encourage households to save more since it would be wrong to go back to the nightmare of the 1990s.

Here we face a dilemma: Should we opt for incentives or constraints? In other words, how many carrots and how many sticks do we need to push households to save more? The World Bank proposes a list of constraints on the availability of banking credits that is likely to discourage households from consuming more than their income and incentives to encourage households to save more, such as tax breaks on financial investments and the introduction of tempting private pension schemes. Some institutional reforms, such as the implementation of individual severance pay accounts and an increase in the number of working women to increase household incomes, would also contribute to an increase in household savings.

To sum up, if Turkey is transformed into a vast reform site in the next few years, we can hope that it would be able to cope with its savings gap problem. But I am worried that economic reforms may be prevented due to political deadlock. Let me also point out that even in the case of successful reforms, the goods that are not consumed in the domestic market as savings will increase and will then have to be exported to overseas markets to avoid a decline in the national income.

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