- 20 Feb 2009
- Working Paper Summaries
When Does Domestic Saving Matter for Economic Growth?
Overview — The researchers begin with a simply stated question: Can a country grow faster by saving more? Long-run growth theories imply that a country can grow faster by investing more in human or physical capital or in R&D, but that a country with access to international capital markets cannot grow faster by saving more. Domestic saving is therefore not considered an important ingredient in the growth process because investment can be financed by foreign saving. From the point of view of standard growth theory, the positive cross-country correlation between saving and growth that many commentators have noted appears puzzling. HBS professor Diego Comin and colleagues develop a theory of local saving and growth in an open economy with domestic and foreign investors. Key concepts include:
- Domestic saving is more critical for adopting new technologies in developing rather than developed economies.
- Familiarity with the technology frontier reduces its cost of adoption.
- Advanced countries readily adopt the frontier technology, but for countries far from the technology frontier, it is too expensive to adopt such technology without outside help. Entrepreneurs in these countries need to rely on foreign investors.
- However, domestic entrepreneurs may not deliver on their input contribution unless they have invested sufficient capital in the project. This co-investment is in turn financed out of domestic saving, highlighting the role of domestic saving in economic growth.
Can a country grow faster by saving more? We address this question both theoretically and empirically. In our theoretical model, growth results from innovations that allow local sectors to catch up with frontier technology. In poor countries, catching up requires the cooperation of a foreign investor who is familiar with the frontier technology and a domestic entrepreneur who is familiar with local conditions. In such a country, domestic saving matters for innovation, and therefore growth, because it enables the local entrepreneur to put equity into this cooperative venture, which mitigates an agency problem that would otherwise deter the foreign investor from participating. In rich countries, domestic entrepreneurs are already familiar with frontier technology and therefore do not need to attract foreign investment to innovate, so domestic saving does not matter for growth. A cross-country regression shows that lagged savings is positively associated with productivity growth in poor countries but not in rich countries. The same result is found when the regression is run on data generated by a calibrated version of our theoretical model.