Equality and Growth in Asia

By Leightner, Jonathan E. | Journal of Economic Issues, June 2003 | Go to article overview

Equality and Growth in Asia


Leightner, Jonathan E., Journal of Economic Issues


If the accumulation of physical capital (tools, machinery, and buildings) is a major driving force behind growth, then the degree of equality will affect growth through its effects on investment in physical capital. (1) There are two opposite ways for the degree of equality to affect investment. Much of neoclassical economic growth theory is built upon the notion that savings constrains investment. If savings constrains investment, then taking from the poor and giving to the rich will increase savings, investment, and growth. I will call this the anti-equality view. Under an alternative, pro-equality, view, taking from the rich and giving to the poor will increase consumption, which drives investment, and, thus, growth. (2) Both of these views accept that the rich save more out of additional income than the poor and the poor consume more out of additional income than the rich. Both views accept that increasing physical capital drives growth. The key difference between the two views is what constrains or drive s investment (Leightner. 1992a).

Both the anti- and pro-equality views are oversimplifications of reality. This can be seen by pushing both arguments to their extremes. If all money is taken from consumers and given to savers, then there is no reason to invest. People invest because they believe that the increased output derived from their investment can be sold. If no one is buying, then there is no reason to invest. Thus, the anti-equality argument fails if pushed to its extreme. Likewise, the pro-equality argument fails if pushed to its extreme. If all money is taken from the savers and given to the consumers, then there is no money to invest. In reality, growth is maximized when consumption and savings are balanced so that there is just sufficient savings to make the investments that investors want to make due to anticipated future consumption levels.

This paper demonstrates (1) why it is difficult to determine whether savings constrains investment or consumption drives investment, (2) how the need for a proper mix of savings and consumption, in a given country, can be circumvented by international trade, and (3) the danger inherent in excessively circumventing the correct mix of savings and consumption. The conclusion proposes a middle road between pro-trade export promotion and anti-trade import substitution that relies on developing domestic markets via optimally mixing savings and consumption. Where possible, examples and evidence from Asia will be used.

Conjoint Savings and Consumption

The biggest problem with determining if savings constrains investment or consumption drives investment is that savings and consumption are collinear. If income increases, both savings and consumption rise. Thus, if a researcher found a positive empirical relationship between investment and savings (dI/dS > 0), it is possible that what underlies the empirical relationship found is consumption driving investment and consumption and savings being collinear [(dI/dC)(dC/dS) > 01. A similar argument could be made against a researcher who found a positive relationship between consumption and investment. To illustrate this point, annual data were acquired for twenty-four developing Asian countries between 1983 and 2000. (3) All data were translated into billions of U.S. dollars. Simple (OLS) regressions between consumption and savings produce the following results (t-statistics are given in parentheses):

1. Consumption 14.459 + 1.297 Savings (8.385) (50.407)

R Bar Squared = 0.877

F Statistic = 2540.87

2. Savings = -5.946 + 0.676 Consumption (-4.487) (50.40)

R Bar Squared = 0.877

F Statistic = 2540.87

These two regressions suffer from severe econometric problems which include autocorrelation and simultaneous equation bias. (4) Thus the estimates found here should not be used for any policy analysis. However, these regressions do make the strong point that savings and consumption are collinear (the R Bar Squared indicates that 88 percent of the variation in savings or consumption is explained by the other one). …

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