Societies are neither saving nor investing enough to secure humanity’s future wellbeing. If governments act urgently to incentivise the right kind of innovation in technologies and behaviours, the necessary saving will follow, writes Dimitri Zenghelis.
Anybody with a mortgage or loan will struggle with the claim that interest rates are too low, but looking at them in ‘real’ terms – that is, the interest rate paid less the rate of inflation – the level is not just low but negative.
This seems remote from the day-to-day struggles so many people are currently experiencing, but for the economy as a whole, it is a problem. It signals that desired investment in the economy is lower than the total amount of desired savings, pushing interest rates down to clear the market. This has been the case for well over a decade.
Yet there is a paradox because it is also apparent that there has been too little saving: the amount of consumption using natural (and other) resources means that as a society we consume too much and save too little to preserve the natural environment and secure a safe climate for our grandchildren.
So – thinking about it in the aggregate – is there too much or too little saving going on?
One resolution to the paradox is to note that neither wealth nor its depreciation and depletion are fully measured in conventional economic statistics. While there are reasonably accurate and timely measurements of private and public financial debt, there is only a partial account of the full range of assets that determine the wealth of society, including natural, human and social capital. Progress is being made on developing a broader suite of statistics to enable a fuller understanding of progress.
More light is shed on the question by asking what society’s preference for consumption is now versus in the future.
It makes sense to weigh the present more highly than the distant future, not least because the future may not come about in any predictable way (think asteroids or global conflict). But some future impacts, such as climate and environmental risks, will materialise quite soon. Moreover, the assumption that future generations will be richer (another reason to discount their consumption relative to ours today) need not hold. Climate and ecological disasters mean future generations may be poorer – perhaps much poorer – if society carries on consuming at the present rate.
It seems clear from the widespread degradation of the environment and climate that globally, economies are not saving or investing enough to secure humanity’s future wellbeing. At a minimum, we are not bequeathing the same capabilities to future generations that we inherited: aggregate saving is too low.
The ‘right’ level of saving is the one that most efficiently attains adequate intertemporal consumption – for current and future generations – and does not lead to ecological disaster. Too little saving will bequeath too few productive assets to the future.
But too much saving is also a problem. This is because the returns to investment diminish as the stock of capital rises, while the costs of depreciation do not. Too much saving means giving up consumption now to replace worn-out capital for relatively little net gain in future wellbeing. Economists speak of a “golden rule” level of saving: not too low and not too high.
So where is today’s economy in relation to this golden rule level?
The answer depends on how productive additional investment will be, and this is not straightforward.
For example, endogenous-growth theory in economics describes the notion that an increase in knowledge has the potential to positively impact capital and labour productivity. But knowledge and innovation are themselves a function of investment in capital and people. For example, investing in computers and training those who operate them induces bright ideas on how to use them. This puts innovation and training centre stage when seeking to generate productivity and support sustainability.
Innovation provides society with the opportunity to boost productivity and reduce environmental risks at the same time by getting more out of the limited resources we have. Endogenous growth means we could steer innovation to reduce the economy’s carbon and material footprint. Investment directed toward innovative green sectors – which requires a clear and consistent policy framework signalling there will be markets for new products – will be likely to be highly productive.
Why then is there a shortage of appetite to invest rather than a shortage of savings – and hence negative ‘real’ interest rates? One reason is the uncertain economic environment and risk of recession. But it also reflects global investors’ heightened perception of policy risk. The private sector is increasingly looking to the government for effective leadership and good governance in bringing about a technological transition – but these are qualities in short supply.
Finally, it is important to measure not only the aggregate level of saving but how it is reinvested across a range of assets. The value of assets depends on how they interact with each other. For example, investment in natural capital, which includes the air, water, soil and living things that provide us with the basic and interdependent building blocks for all activity, generally increases the returns to investment in other assets.
The complex interrelationships between physical, human, intangible and natural assets exacerbate the impacts of placing undue stress on any one form of wealth. Natural asset depletion, such as deforestation of the Amazon, mass extinction of fish or insects or the pollution of our atmosphere by greenhouse gases, cannot be adequately compensated by produced and human capital.
Prosperity now and in future will depend on innovation that alleviates physical and environmental constraints. This requires investment in a range of critical and future-proofed assets that underpin our wellbeing, avoiding being locked into additional high carbon, resource intensive infrastructure and behaviours (making the UK Government’s recent decision on a new coal mine highly regrettable).
So the question ‘is there too much or too little saving’ turns out to be misspecified. What matters is how the savings are invested. If governments act urgently to incentivise the right kind of technologies, the necessary saving and investment will follow.